Zions Bancorporation, National Association (ZION) Earnings Call Transcript & Summary

Good afternoon, everybody. So before I introduce the last bank presenter of the day, I just wanted to thank all the investors for joining us, albeit virtually, at this year's Future of Financials Conference. Without further delay, I wanted to introduce our conference's last presenter. That's Zions' Chief Financial Officer, Paul Burdiss. Welcome, Paul.

Thank you, Erika. Thanks for having us.

Absolutely. Paul, I just wanted to kick off the fireside with a question on the health of small business. Clearly, you're well known for having major market share with small businesses in the Western United States. With the presidential election ostensibly behind us and an economic recovery potentially also underway, how does Zion see the recovery of small business in 2021?

Yes. Our small business customers have proven to be, I think, very resilient. And you see that in our credit loss statistics that we've been reporting here over the course of the last several quarters. I think the government stimulus targeted to small businesses has been particularly helpful for our client base. And as a result, certainly, I like to think and believe that maybe difficulties that could have come about due to a really rapid change in the environment have been helped by the government and helped our customers to reset their businesses and really operate in the new environment, gave them time to reset the businesses to operate in the new environment and in a reasonably healthy way. That is to say that I believe that our customers largely have been able to balance the cash flows of their business into operating into what is the current environment.

Two-part question coming up as a follow-up. Scott McLean has mentioned several times that most of the $7 billion in PPP proceeds are still sitting in deposit accounts. So the first question in the two-parter is, how crucial is a second round of PPP to the health of small business going forward?

Well, that's hard for me to speculate on, how particularly useful that will be. I can say that our customers seem to be in pretty good financial shape as indicated by deposits in their accounts. As you noted and has been noted previously, our customers have a lot of -- it seems like our customers have a lot of operating cash in their deposit accounts. And in fact, aside from PPP, we've seen a lot of organic growth in our deposit accounts over the course of the last couple of quarters. So from a cash flow perspective, it would appear that, in particular, our small business customers are pretty healthy. But sort of what happens from here on out, how the government reacts to get into that, I think, is a little speculative just because I don't know precisely how the economy is going to react over the course of the next 6 to 12 months. And I'm expecting that the federal government will react to that.

And given the strong liquidity position of your small business clients, how much do you think that positioning slows net loan growth going forward?

Yes. Our customers seem to be in pretty good shape financially, although I will say much of small business is really around deposits as opposed to growth, right? I mean it's a deposit-rich business. So when I think about growth in small business loans, it's a portion but not our entire balance sheet. As you know, we've got -- we lend into a lot of different categories, including consumers. And so I'm hopeful our lenders, I think, are somewhat optimistic in terms of how they see loan growth evolving from here, but I am not expecting over -- certainly over the medium term that, that influx of cash will adversely impact our loan growth in a very large way.

So switching topics a little bit. A major theme in this year's Investor Day, and I actually can't believe that was this year, centered around the bank's tech investments. The third release of FutureCore is now underway, and the full replacement of your online and mobile infrastructure should be complete by 2022. Can you provide us an update on how these projects are progressing?

Sure. On FutureCore -- I'll start with that. On FutureCore, you may recall we are replacing all of our core systems, loan and deposit. All of the in-scope loans have been successfully converted over the course of the last couple of years to the new core system. As you correctly point out, deposits will be in play. Deposits are sort of a significant factor of complexity, far more complex than loans to deposits due to -- or loans due to the number of transactions that occur in the system on a daily basis. And so that's a much bigger conversion process that we expect to be done into 2022. So that replaces a core system. The other elements are more customer facing, as you said, sort of more of an improved digital experience for our consumer and small business customers. And again, those are progressing. We expect those to be in place, again, in 2022. I will say that the pandemic has impacted the workforce, and we think we're up and running and everything is operating as smoothly as it can be given the environment. But we have indicated that there could be some delays associated with that, sort of the longer-term knock-on effects of the pandemic on the workforce. But as of now, we are expecting to continue to have both of those operational here by the end of '22.

As you complete this project, how much, if any, cost savings could be there? And if there are cost savings that are associated with the completion of this project, does this fall to the bottom line?

Cost savings are an interesting topic when you replace -- the core system is expensive, right? And we are capitalizing that. We provide updates in our 10-K and 10-Qs on the capitalized costs associated with that. The old systems for us and for, I would say, most banks have been depreciated for decades, right? Fully gone and depreciated for decades. And so the ongoing cost is really maintenance and pretty minor. In this case, because we're investing so much in this project, we will have amortization of capitalized costs over the next 10 years. And so the cost savings really would come about through operational efficiencies. As we take out the complexity of the current environment and we replace it with a new, modern core, my expectation is that we will realize operating efficiencies, but my expectation is that those operating efficiencies will be reinvested in the business. We had, last year, for example, through ongoing automation efforts, we say it's a little under 100,000 labor hours through the application of bots and other things. The new systems that we're putting in place are allowing us to be much more operationally efficient. But again, I expect those to be reinvested into the business.

So Paul, maybe digging into that a little bit more. Zion has done a great job improving PPNR over time. Obviously, the rate environment hasn't been helpful for banks, but you've been able to really keep core expenses relatively stable. As you think about -- you balance those investments that you mentioned, can you discuss your ability to keep expense growth under control in the current operating environment?

Yes, this gets to this operating efficiency thing. Much of the expense control has really come through operating efficiencies. We consolidated our bank charters several years ago. We are now one bank. We no longer have a holding company. So we're only a bank. So we've created, I would say, a more simple operational structure. In -- a dividend from doing that is continuously improving our operations, making them more streamlined. That's been a really big function of our ability to hold our expenses flat. Although, I will say there's a human resource element to this, too. And you may recall a year ago, almost exactly a year ago, we announced a reduction in our workforce of about 5%. And that has -- obviously, we saw that because we thought interest rates were going down and tried to maintain balance between revenues and expenses. Obviously, the environment that we foresaw was not the environment that we're living in. But I do feel good about the fact that we were really proactive in managing those expensive -- expenses late last year, which has set up -- set us up well this year for another year of controlled noninterest expense.

Something that investors always point out to me favorably, a portion of Zion's executive management incentive compensation is tied to the bank achieving multiyear financial targets, the Value Sharing Plans. Can you discuss how the plan functions should the bank not meet preestablished performance targets?

Yes. There's a really good -- I'm not going to get into all the intricacies. Actually, that year -- is modified just a little bit every year. But generally speaking, there's sort of an absolute performance and a relative performance aspect to those plans. And while there is sort of a discretionary element that is also attached, by and large, quantitatively, we accrue those plans in accordance with our performance. And again, its performance on both a relative and an absolute basis. Again, proxy statement is a pretty good description, I think, of how they work. But the whole idea there is that, as you correctly point out, we are trying to tie long-term compensation to long-term performance. And so particularly, the VSP plan is centered on that.

Got it. Switching over to revenue. Approximately $2.5 billion of the $3.5 billion in interest rate hedges are expected to mature in 2022, reducing interest income by $46 million year-over-year. Without an increase in rates -- although, clearly, the yield curve has deepened over the past couple of days. But take that aside, how does management plan to support net interest income growth going forward especially given that there seems to be a limited opportunity to reduce liability costs?

Yes, the -- so net interest income -- aside from rates, net interest income really needs to be managed through balance sheet growth, and that's what we're focused on doing. As I said, we've got a real influx of deposits. We have one of the lowest-cost deposit bases in the industry. I'm certainly hopeful that we can continue to grow the balance sheet, in particular, loans, to support that noninterest income -- net interest income growth. I will say, though, the steepening of the curve is encouraging. Yes, one of the things that you really can't hedge over the medium-term is a sort of a structural change in rates, which is really what we've seen. However, I'm hopeful, as I said here, over the next couple of years, we will begin to be paid for duration again. And when that happens, we've got a lot of capacity to continue to put hedges on -- hedges, i.e., swaps on the balance sheet. A lot of our asset sensitivity growth recently has really been driven by deposit growth. And so to the extent those deposits are sticky, we can continue to add duration on the asset side of the balance sheet, again, to the extent it makes sense and we're getting paid to do that.

And just as a follow-up here, I think the answer is most of it, but how much of the deposit growth that you realized have been in operating accounts?

Yes. I don't have the specific proportion, although I do say, and as you know I've been following this for a long time, that we monitor that very closely. And this does appear to be a very operating account sort of intensive growth, so I feel very encouraged about that.

And just as a follow-up here. It seems that the market consensus is lower for longer, similar to how, in 2010, we thought the Fed was going to raise rates soon and we awaited for 5 years. It seems like you hinted to the view that you do think that there could be elements that could lead to more sustained curve steepening from here. Is that -- did I take that away correctly?

Well, look, I'm not an economist, but I do look at sort of the fundamental aspects of what's going on with the money supply, what's going on with the federal debt and deficit. And the laws of supply and demand, as far as I know, have not yet been repealed. It's hard for me to imagine that while the Fed will maintain a very sort of stimulus-oriented stance over the course of the next several years, they've been talking about that, that does not necessarily mean that the curve is going to remain extremely flat. We're planning for that, a reasonable chance that there's the outcome of that. But I also believe that there's a chance that we will see curve steepening. And when we think about our balance sheet and the profitability of our balance sheet, we're not only tied to short-term rates, but we've got exposure sort of added to the medium part of the curve. And so to the extent the curve does steepen, that certainly will be helpful for our net interest income.

And Paul, I asked you earlier about small business, and you alluded to overall loan growth also earlier. Maybe I'll be more specific in this question. In terms of your larger commercial clients, what has their sentiment been? And how does the election outcome and potential quicker resolutions to the pandemic impact switching from a defensive stance to an offensive stance in terms of growth?

Well, I don't know that the election outcome has a really big effect certainly over the near-term on loan growth, although I will say uncertainty. Nobody likes uncertainty, including our borrowers. But to the extent that, that outcome becomes more certain over time, I am, I think, much more interested in the potential for the relief on the pandemic, that of a vaccine or herd immunity or some other thing they create. I'm certainly hopeful that as we get into the -- and I'm, it's me speculating, certainly hopeful by the time we get into the middle of next year, certainly, we'll have a much more certain path in terms of our economy largely due to, hopefully, a positive resolution to the COVID-19 pandemic. And so when I think about sort of where we're sitting and the things that could happen over the next 6 to 12 months, I'm certainly more optimistic than pessimistic of the outcome.

On the municipal credit book, which has seen really nice growth over the -- recently, I think it was up 24% year-over-year, and James will correct me if that number is wrong. But could you discuss how much more opportunity or runway for growth is there in the muni book?

This is, I think, a nifty little business for us. An artifact of our model is that we're very local, and we get to know our communities very, very well. This municipal book, a lot of it is, I would say, very granular secured loans to very small municipalities. Over time, we have had an excellent, knock on wood, excellent credit performance in that portfolio. Oftentimes -- again, these are not sort of heavy bid situations against the global banks. These are often, I would say, either very limited bid situations or, sometimes, just negotiated transactions where we are the only bank at the table. This has proven to be a very, very good business for us. And we are mindful of pricing. It is a little thinner spread than our typical loan, right, because the risk is so low. So we do internally establish minimums below which we won't do business. But the business itself on a risk-adjusted basis is a really strong business. And we do have concentration limits, credit and otherwise, that were not -- we're not close to those concentration limits. So we could continue to see that growth -- that type of growth for the next couple of years pretty easily, again, to the extent the risk and return dynamics remain positive for us.

Tying back to the conversation you were having earlier about the yield curve and the nature of the deposit growth that's been coming in, you noted in the third quarter call that the surplus cash is -- had gone to paying down debt and increasing short-term investments. You mentioned there's going to be a time to take on some duration risk. What do you need to see in the marketplace and with the rate market before more meaningfully deploying your excess cash.

Yes. So we're talking about our balance sheet, of course, and we have taken this influx of deposits and paid down more expensive wholesale borrowings. One of the artifacts of our net interest margin is that we've got more in cash on reserve at the Fed earning kind of 10 basis points, which I think is the IOER rate. So I feel good about the deposits, the stability of those deposits. That feels good over time to the extent the yield curve steepens. As I said, we have not, over the last 6 months, really been paid at all for duration. And so to the extent, the curve steepens a little bit, and we feel like we are being paid for that duration. It will certainly make me and, I think, our ALCO more comfortable going a little further out the curve. So it's really a combination, Erika, of sort of ensuring that the deposits are stable and then also sort of matching up the cash flows on the asset side of the balance sheet with the potential cash flows on the liability side. Hopefully, that makes sense. It's really -- so it's really a function of the stability of deposits and the interest rate environment.

In your 10-Q filing, you -- I'm going to read this off verbatim. It read, "Yields on new loans have been only modestly lower than yields on maturing loans." Can you discuss how loan pricing is evolving in the current environment and where you're seeing some spread widening?

Sure. So this is a topic that, as you know, from listening to the call, I didn't get into a lot of detail on this. And the reason is that in any given month or quarter, the -- sort of the average credit quality of loans coming on or going off could be highly variable. And so I don't want to make a lot of speculative comments around sort of what that net number looks like. However, it is factual to say that -- and as we said in the Q, in the third quarter, the yield of the loans coming off was relatively close to the yields coming on. And so as we think about that over time, what's happened is we saw a lot of, I would say, generally, either coupon or spread compression over the course of the last 18 to 24 months. It feels like that has really stabilized and even turned around a little bit, interestingly, in the last 3 to 6 months. And so that comment is just meant to be indicative of the fact that there is not a massive difference right now in the coupons of loans coming off versus those coming on. So to the extent we are growing loans and replacing loans, right now, it is not a really big negative on the average loan yield and, therefore, the net interest margin.

Paul, you and the rest of your management team have talked a lot about your success administering the PPP program. And you noted that you developed 14,000-plus new-to-bank customer relationships with PPP.

Yes. Very proud of that. Yes.

Maybe talk a little bit more about how you plan to retain and deepen these new relationships.

Right. So we've got -- as you can imagine, we have the data on all these folks, a lot of data on all these folks, and we are very actively creating call lists and going out and aggressively calling on these new customers. Although I will say, because they're small business customers, as noted earlier, small business -- an artifact of small business is it's very deposit intensive, not always loan intensive. And so we're looking to sort of integrate them into the bank. That doesn't necessarily mean we're going to see a spike in loan growth because a lot of small business customers are really deposit oriented.