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

This is Jason Goldberg, and I cover the U.S. large-cap bank stocks here at Barclays. And this is our 19th Annual Global Financial Services Conference. Next up, very pleased to have Zions Bancorp. And from the company, we have their Chief Financial Officer, Paul Burdiss. [Operator Instructions] There's a button called survey. If you click on that, there's our typical automated response questions in which you can answer 3 or 4 questions about the company, and we'll get to those either in this session or later tonight. Paul, thanks for joining.

Maybe the best place to start is just your thoughts on the overall economy and the pace of recovery. Obviously, Zions operates in several markets throughout the western part of the U.S. Some have similarities. Some obviously have their differences. But you've seen a lot of positive trends so far this year and I think more recently some concerns around supply chain constraints, some labor shortages and Delta variant. But just maybe talk to kind of what you're seeing within your footprints.

Sure. Well, generally speaking, and we talked about this on our July second quarter earnings call, we are seeing resilience in our markets. We're seeing increased kind of pipelines and confidence -- lending pipelines and confidence. And it's interesting because we cover really the Western U.S. from Texas all the way to California and up to Washington and kind of all the states in between. And there are a wide variety of kind of political oversights as it relates to those economies. And it's really interesting, though, because even though the political reaction to all the things that we are seeing has been pretty different across the footprint, generally speaking, we're not seeing a big difference in activity across the footprint. And generally speaking, I would characterize that as pretty positive.

Got it. And maybe you mentioned increase in lending pipelines, if we kind of just maybe delve more into loan growth, I think commentary so far in the first half or the first day this conference on loan growth, I would say, has been somewhat mixed, varied by both geography, by company, by loan category. I would say on the second quarter call, you seemed maybe a little bit more optimistic on loan growth as you're beginning to see some green shoots. Maybe just talk to in terms of what you're seeing into 3Q, and we will pick up from there.

Sure. Well, as a matter of practice, as we don't provide a mid-quarter update, but I can provide some additional details. So we -- in the delayed earnings call, again, at the end of the second quarter, what we said and what we intended to convey was that we had seen loans coming down over the preceding several quarters, and what we were starting to see felt like was a bottom forming. And then the confidence around that sort of bottom forming was all of this anecdotal evidence we are receiving from the front line. In addition to those things, maybe something a little unique to us is that we, in some sense, tried to create our own success in putting out some specials in some of our lending categories, home equity lines of credit and, maybe more importantly, owner-occupied lines. And what I mean by that is that we are sitting on a sort of almost $90 billion balance sheet. We've got about $13 billion of excess liquidity. And that's despite having increased the size of our investment portfolio over the preceding several quarters by kind of $1 billion-plus a quarter. The quality and the sort of magnitude of deposit growth over this last year has been really significant. And so we're sitting on this, I would say, somewhat underinvested cash position. It's underinvested because we have been concerned about the duration of those deposits and how long it will be around. But as time has moved on and we've provided -- we've performed the analytics in the portfolio, we're getting increasingly confident that this cash, these deposits are sticky. And so we're thinking about ways to deploy that. One of the ways that we came up with as it relates to specifically loan growth was to offer some teaser rates. And the idea is that these teasers would have a yield that exceeded the amount that we were earning at the Fed and, therefore, would be revenue and net interest income accretive and could help to spur some loan growth and could help to waive some additional customers into the bank. And so we were optimistic also on that second quarter call in July that this sort of special loan program that was meant to deal with an excess liquidity position, we're trying to turn it into a competitive advantage through some pretty aggressive offering on yield on, again, HELOC and owner-occupied loans.

I mean can I ask in terms of your initial kind of takeaways or results with these special programs?

Yes. We'll talk about that on the third quarter call. But as I said, in that July call, I think we were pretty optimistic that we would be able to generate a little growth in this program.

And you talked about loans bottoming and you felt good because of good anecdotal evidence, I guess, has -- over the last, I would say, few weeks, it feels like the supply chain issue has gotten a little bit worse, Delta variant's got a little bit worse. Has that changed the tone of your kind of conversations and kind of this anecdotal evidence that was positive a few months ago?

Yes. I will say, Jason, again, without providing a mid-quarter update, I -- our core customer is probably smaller than -- the average core customer is, I think, smaller than the average regional bank's core customer. That's true, particularly, in commercial. And so I have not personally seen any evidence that those disruptions are causing disruption in our customers from a credit or other -- or sales perspective. Not to say it doesn't exist. I just haven't seen that evidence.

Got it. And I guess when we do start to see loan growth come back, I guess, which are the areas that you think would kind of come back first?

Well, there's going to be some speculation involved in that. I think residential mortgage, we're continuing to see refinancings away from us. And that's because we, from an interest rate risk perspective, are very reluctant to put 30-year product on our balance sheet. And so given the sort of the shape of the curve, I'm expecting that to continue to maybe run off a little bit. And so I'm hopeful that where we will see growth is in certain aspects of CRE, although -- commercial real estate, although as you know, that's limited by our concentration risk limits. But in particular, C&I and ideally, owner-occupied and growth in municipal lending has also been strong over the course of the last a couple of years, and I'm hopeful that while that's a more competitive market today, we will continue to see growth there.

Got it. And just maybe broadly around net interest income, your 12-month outlook slide has NII increasing modestly. Beyond loan growth, can you maybe just talk about some of the other drivers that you're thinking about? And is that outcome dependent on rates? Or are there kind of other balance sheet levers?

Right. There's not a rate component to that. But as I said, what we have is a pretty large excess funding position that we are trying to leverage as much as possible. So a couple of things going on there. One, again, we've got over $10 billion invested at the Fed, that's earning 10 to 15 basis points. We're increasing the size of our securities portfolio. So that's adding 150 basis points to that yield. I expect to continue to do that. We've also got a large and in some sense sort of a disproportionately large PPP loan portfolio. That portfolio, we serviced 77,000 customers through PPP loans. 20,000 of those were new to the bank, you may recall, and you've heard us say previously. And so that portfolio, even though it's winding down as those loans receive the SBA guarantee payments, they are effectively maturing. And so the upfront fees are being amortized into revenue. I expect that to occur over the course of the next couple of quarters. And then any increase in rate, there's no increase in rate that's implied in that outlook, but any increase in rate would be additive to net interest income as well.

Okay. Two things you mentioned that I want to delve more into is, one, kind of putting deposits to work, and second, PPP. I guess on increasing -- putting this liquidity to work, I think, as these deposits maybe turn out to be more durable than initially thought. Just how are you kind of thinking about that opportunity? How much are you willing to do? And particularly, the tenure is still at [$1.3 billion]. So just how does that factor into your thinking?

Sure. Well, a year ago -- I think you probably heard me say a year ago, we believed that these deposits would largely leave the bank in the ensuing 3 to 6 months. Obviously, that didn't happen. As we dig into our depositors what's happening, these are operating accounts of our customers, the deposits are not leaving the bank. In fact, we've got more deposits coming in, not only from PPP borrowers but from others as well. The deposit growth is, I would say, pretty widespread and feels much more resilient than we originally thought, which is what gives us confidence to incrementally add to the investment portfolio and as we have done over the last several quarters. Now we could probably move sort of bigger chunks into the investment portfolio. But to your point, around the absolute level of rates, we're not entirely -- the ALCO committee is not entirely comfortable sort of moving all of our chips in, and so we're trying to meter that in over time. As it relates to the duration of the deposits, though, as is implied by all of that, it feels like these things are a little stickier than we originally thought. And so my expectation is we will continue to invest those deposits out the curve over the near term.

Got it. And then on PPP, obviously, you guys did remarkably well in that program. I guess, first, just how should we think about -- there's unamortized PPP kind of coming back into net interest income. It seems like banks are seeing differing degrees of recognition over the next few quarters, some faster some slower. Just kind of any way you can help frame in terms of how we should expect that to flow back through NII?

Yes, it's a little speculative. I mean some of it's dependent on the borrowers and some of it's dependent on the SBA. So we don't completely control that process, right? But what we have seen, and you see it in the yield, we had a yield of -- on PPP loans of $398 million in the first quarter and $456 million in the second quarter. That's on effectively a coupon of 1% and an amortized upfront fee adjusted yield of about $175 million. So you can see the effect of that -- those guarantee payments coming in. My expectation is, and it's as I said a little speculative, is that we're going to continue to see a lot of activity over the course of the next several quarters, certainly the next 2 and probably sort of into next year probably takes us through the middle of next year is my expectation.

Got you. And then I guess maybe more importantly, clearly, you've made a lot of PPP loans. Can you maybe just talk to your ability to kind of convert these new-to-the-bank PPP customers to be more than just PPP customers and just sell them additional product, get additional relationships with them? And just how do you kind of size that overall opportunity?

Yes. Well, as I said, through PPP, we serviced existing customers and new customers. And of the 77,000 PPP customers, 20,000 were new-to-the-bank customers. Now these are typically much smaller businesses. And as such, small business typically is more of a deposit-rich sort of customer as opposed to a lending-rich customer. So my belief and expectation is that these will be net funds providers for the bank for some time. And we have historically been focused on the value of our deposit franchise. We continue to be focused there. And so where we're really focused with those new PPP customers is just to sort of bring over their operating business to our bank through selling in some pretty sophisticated treasury management products that are scaled down for a small business. But to the extent we can sell those products in, yes, we get some fee income from that. But maybe more importantly, we get the stickiness of deposits that allows us sort of to have a funding advantage over time.

Got you. And then maybe turning to the fee income side of the house, maybe just talk to kind of what you're seeing there. What are some of the bigger opportunities as you look to improve that revenue base?

Sure. I'll mention a couple of things. One, on residential mortgage, there's been an enormous amount of refinancing activity, and that team has done a fantastic job of capturing that. We have seen mortgage fee income has really been additive over the last several quarters and last year really to that fee income. And this is as other things have dropped off, card activity and other lending activity related to these have kind of dropped off. The sale of capital markets products, especially interest rate swaps, over the course of last year has been strong. I think that capital markets is also a real opportunity for growth. As a commercial bank, I'd say we were kind of under -- capital market's revenues are sort of underrepresented relative to the size and -- size of our balance sheet and average sophistication of our borrowers, but maybe most importantly is wealth management. We've got a fantastic trajectory in wealth management. Again, this is a business that fits in so well with our core customer and who they are, and we've got a great team in wealth management, who are really -- in fact, we broke out, you may have noticed this year, we broke wealth management out as its own line item. That's due to the success and the growth of the wealth management team. And so that's another fee income opportunity for us that I expect will continue to grow.

And then I guess on the expense side, I think you're calling for, at least your 12-month outlook, a modest or slight increase year-on-year. I guess as you invest in these -- some of these growth initiatives, what is your ability, I guess, to try to help fund them by taking costs out elsewhere?

Yes. We continue to have an opportunity to manage our costs, hopefully, pretty aggressively. But we are -- to your point, we are making some pretty significant investments in the business. I will tell you, one of the things that we're paying a lot of attention to is compensation expense. I understand that sort of price increases are allegedly transitory. On the other hand, salary increases are not. And we're seeing an increased competitive market for high-quality people. And I think us and every other bank and every other industry is really dealing with that. And so that's -- for me, personally, that's a point of concern as I think about. When 2/3 of your expense are comp-related expenses, which is what it is for us, that is a point of concern that we're paying a lot of attention to.

Got it. And then just, I guess, kind of walking through it, shifting gears to credit quality, results have, obviously, been strikingly good for you and the rest of the industry I guess as you look at your portfolio, I guess, any areas of concern, CRE is something that comes up. You hear about particularly kind of maybe in the retail and office segments as they kind of go through some potentially structural changes. Just how do you view the role of that portfolio and just your loan book in general?

Yes. Well, let's start with commercial real estate. So commercial real estate is an asset class that we know really, really well. I think we underwrite it very, very well. We -- however, one of the things we are concerned about is concentration risk. When I think about what went wrong in the great financial crisis was we had some outsized concentrations in commercial real estate. And so since then, we have put in hard limits, concentration limits in commercial real estate. We have them in commercial real estate. We have them in energy. And so our growth in those portfolios has been limited because we're adhering to sort of larger portfolio-level risk limits. That being said, on commercial real estate itself, there is a lot of speculation about weakness in commercial real estate. But I think what we're observing is that there continues to be ready buyers for real estate assets. So when they go up for sale, they are being sold and sold relatively quickly. So it's an asset class that I think we understand and I feel good about, and I can't say that we're seeing stress there today.

And then, I guess, the industry as a whole has benefited from reserve releases and sounds like expected those to continue, and I think there's somewhat of a debate, do we go to CECL day 1 levels, do we go below those levels. Obviously, for you, you had a benefit there. Just how you're thinking about the overall allowance in the context of an environment where loan growth is somewhat muted and at the same time, credit quality is just really, really benign?

Yes. That's kind of the fundamental issue, right, is that there is not -- has not been a lot of loan growth. And our net charge-off experience has been pretty exceptional over the course of last year. But as you know, CECL is forward-looking, not really backward-looking. And so it's really -- our reserve is going to be really built upon the economic forecasts that are sort of relevant at the end of any given quarter. So I -- it would be hard for me to say, hey, let's look back at day 1 CECL and sort of circle around that. I just don't think we can do that analytically because that's not what the process is built on, and that's not what it would create. It's really built upon the sort of the underlying credit quality of the portfolio and the economic forecasts and the reversion periods that are built into the CECL models.

No, makes sense. Makes sense. I guess on capital, you had a decent buyback this quarter than you actually upped the buyback intra-quarter. So that's good to see. You still have a CET1 ratio that's probably the highest or one of the highest in your peer group. I guess, how do we think about what the appropriate level for CET1 is? When do you plan to get there? Because clearly, there's probably even more share repurchase you could do if you so choose.

Right. So a couple of things there. One, our primary mechanism for managing capital is our stress test. So we're not a CCAR bank anymore, but we built all of that stuff. So we're continuing to use it, and I think we use it pretty effectively. So as we think about the -- philosophically, where we want to be as an organization, we want to have a little less risk in the balance sheet than average and a little more capital than average, right? And I think we're demonstrating the risk side of that, right, through exceptional charge-offs and other things. The profitability of the organization over the course of the last 18 months has been pretty high when you consider the PPP lending activity and then the reserve releases that have come on top of that, so those things [Audio Gap] from where the peers are and where the risk of the balance sheet lies. And so as a result, you saw us we announced the -- I think it was $50 million in the first quarter, $100 million in the second quarter, we announced $125 million for the third quarter and then upped that by another $200 million just a week or 2 ago in terms of $1 million of share repurchase. And the reason for that incremental $200 million was what we saw was the trajectory of sort of that capital CET1 pass relative to peers was just -- was not correct. It wasn't where we wanted it to be. And so we're hopeful that with the incremental share of purchase, we can start to bring that down. In terms of targets, we have consistently, over the course of the last couple of years, stated that our target is to be at sort of a median plus CET1 ratio relative to peers. So that gets back to my sort of philosophical statement around what we'd like to have is lower than average risk and sort of better than average capital. Better-than-average capital in this case is being defined as let's look at the median regional bank, and we want to be just a little bit better than that. The median for our peer group at the end of the second quarter was 10.3%. So we were 100 basis points off of that median, which is the reason for the accelerated share repurchase.

Got it. And then maybe could you update us your thoughts on just overall bank consolidation? Clearly, I just look at my coverage, whether it's Huntington, PNC, Citizens, Silicon Valley, there's been a whole list of bank, bank-like acquisitions announced this year, as I know Zions did the Amegy deal years ago and a lot of smaller ones before that. In an industry that's clearly consolidating like and continues to consolidate, it feels like scale is becoming increasingly important. Just how do you view that?

Yes, we're not -- for our core customer, technology is important, but we don't believe scale is especially important. I think that for retail customers, I think scale actually is important because what you've got a lot of very small transactions, and you need to reduce that marginal cost of transactions to the point where those little -- those kind of scrolling transactions make sense. For our core customer, that's not as necessary. However, our core customer also, though, expects a first-class technology experience. And so I don't think we need scale for that. I think that we can make the investments and we have been making the investments to be really relevant from that technology perspective. So my personal view is that we do not need to continue to add scale to continue to be relevant.

Got it. And I guess you mentioned technology is important. And I think one of the technology initiatives you've been focused on is just the new core processing platform. Can you maybe just update us where you are in that process, the benefits of that, where you think you are relative to peers and just how that impacts maybe the cost line over the next couple of years?

Yes. So if I could, I'll just do a quick little history item here. Many -- most banks have core systems that were built, as you know, decades ago. And think about what's happened in the last couple of decades. If you go in the '80s when a lot of these were put in place, I don't even know if we had ATMs there. If we did, they were just emerging, right? There was -- the way that you interacted with the bank and with the core system was through a live person in a teller line in a branch. And think about the evolution that's occurred since then. You've got ATMs, you've got online banking, you've got mobile banking. People are moving closer and closer to their money. And the way that, that core system has to interact with all these other systems is becoming increasingly complicated. And therefore, the core system is becoming, as the technologists like to say, sort of increasingly brittle. So yes, it's sort of burned in and it's reliable, but it can break easily the more sort of ornaments you hang on that tree. So it was important for us for a lot of different reasons, one of them being risk management to ensure that we can continue to grow and develop as the product evolution accelerates towards digital banking and direct access from consumers. And so we embarked on this core transformation effort nearly 10 years ago, I think now we've -- with all of the in-scope loans have now been converted, they're on the new system, deposits is the next one, and it's a big one because it's sort of, in terms of numbers of transactions, you can imagine, it's sort of a logarithmic progression from where loans are. So it's really important that we get it right. We've got a great team working on that. Expectation is that, that's going to be up and running and in place in 2023.

Got it. [Operator Instructions] We do have a couple of questions, Paul, which I'm going to read out. I guess first is, you talked about increasing the size of [indiscernible] portfolio, the unamortized PPP fees, slowness in loan growth. Can you just talk to how that fits into the overall net interest margin expectations in the near to intermediate term?

Yes. So net interest margin is a complicated stew, as we all know. And so what's happened is, as deposits have come in, that's a good thing, it's created an excessively large cash position. And as I think I said, we are kind of underinvested. And the reason we're underinvested is that we're not sure about the duration of those liabilities. As those liabilities become more certain in terms of their longevity, you will see us, I'd say, be more confidently invested. So in the near term, the cash position is driving the margin. And so what you're seeing is there's a pretty large depressive effect on the net interest margin. The headline margin is not necessarily indicative of sort of the core earnings strength because of all the cash we have. And then the other which was accurately described in the question is PPP loans, the level of forgiveness is creating a pretty large fluctuation in yield on what is about a $5 billion portfolio. So a pretty significant portfolio for our size organization. So these things are working together to create some noise, I'll call it, in the net interest margin. But I hope you will find that in our financial disclosures through our earnings release and through our 10-Q, we try to provide enough information. So that you could tease out those elements and really look at the structure of the core margin. Given where rates are, there's probably not a lot of room to move on deposit. That is moving them lower. We've already got one of the lowest, if not the lowest, cost of funds, particularly among the regional banks. The -- as we invest cash out the curve, that should be incrementally a little bit additive. It feels like the front book, back book and the loan portfolio, it was a -- couple of quarters ago, it felt like there was a good sort of 25 basis point compression there. You saw in our Q that we filed in August that we think it's moderated -- that's moderated quite a bit. So I think the -- and any increase in rates sort of from 0 out to sort of 5 to 7 years is going to be marginally helpful for our net interest margin. So I'm hopeful that the core margin, if you strip all these things away, will be relatively stable. Net interest income should be a little bit better as -- again, as we invest the cash from -- into the securities portfolio. So a really long-winded answer, but the margin is pretty complicated, as you know. And I would not just look at the headline number, particularly in our bank, you really need to dig into it and look at sort of what are the core drivers.

No. Makes sense, makes sense. Another question is, your CEO announced either late last year or early this year some health issues. Can you update us on his prognosis?

Well, yes, I'm not sure what I can and can't say other than, I can't remember what he's disclosed or not. But I would say, in my interaction with Harris, our CEO, which are regular, daily probably, he is fully engaged at work and has been. I have the sense that he's not feeling bad that is to say I have the sense of his work that he's doing okay, because he's -- as I said, he's in the office and working hard every day alongside the rest of us.

That's good to hear. Just another question. Given -- in light of all the uncertainties out there today, just how are you approaching the 2022 budget season? And how important is positive operating leverage when putting that together?

Yes. So that's kicking off now operationally. This is kind of a time of year where we kick that off. And so we're putting together our revenue and expense forecast. Positive operating leverage is absolutely important and has been to us. But we are going to have some revenue headwinds, I think, next year as we think about PPP, what that's meant for us this year and how that might wane as we move into 2022. So we're trying to put -- I can't really speak to sort of where that's going to land yet because we're really in the, I would say, in the sort of the deepest part of those conversations right now. But we continue to be focused on efficiency ratio, we continue to be focused on positive operating leverage, and we're going to get the best outcome that we can in the environment.

Okay. And then we have one. Zions is a leader in small business lending. Can you talk to the sentiment of a small business customer base and any changes in the last couple of months?

Well, I can't necessarily speak to recent changes. But what I can say is that I've been really, really impressed with our customers' ability to change their business model to operate in a highly disrupted environment, right? When you go back a year ago, there was a narrative there like, "Oh, small businesses, they're going to get crushed, and Zions is going to be right along there with them." But what's happened actually is that small businesses have found a way, as I think I said earlier, to balance their cash flows in a really difficult environment. And anyone who goes to a dentist or restaurants or other small businesses, you know that these businesses have largely found a way to balance their cash flows in a way that has allowed them to, in our balance sheet, grow their deposits and their credit quality, creditworthiness has not declined. So all of the things that have happened over the last couple of months are an extension of what's happened over the last year. And I've been really, really impressed with our customers' resiliency and ability to deal with a rapidly changing and very difficult environment.

Makes sense. And then earlier, you mentioned that bank acquisitions didn't seem to be top of the list. Can you talk to just any thoughts around kind of bolt-on acquisitions, particularly to build out some of your fee income business areas?

Yes. That's something that we're always sort of mindful of. I would say that it's far more -- there's far more value in building it than buying it because when you buy it, you end up sort of paying for what somebody else has built pretty significantly. So it's something that we've looked at and we do look at and we consider, but Harris is a value investor is the way I would characterize that, and we certainly haven't seen anything that would outweigh our ability to grow these businesses.

Got it. And I guess lastly, Zions is one of the more asset-sensitive banks and, per its first 10-Q, its asset sensitivity increased even further in the second quarter. I guess, what are your thoughts on dampening that asset sensitivity either synthetically or through other balance sheet actions?

So as a long-time sort of bank operator and treasurer -- bank treasurer for 10 years, asset sensitivity is something near and dear to my heart. And you always need to look at the source of the asset sensitivity. In our case and -- well, in every case, the source of asset sensitivity always ends up being deposits, right? Deposits drive everything on the balance sheet. And so this gets to, yes, we are very asset sensitive in the models, but there's an overlay, there's sort of a management overlay of expectation around what is the longevity of those deposits, what is the duration of those deposits, and how might that duration behave sort of differently than the way we have it modeled, right? So yes, we're very asset sensitive. And if those deposits stick around, we will continue to be very asset sensitive. And this gets back to one of my initial comments, which is we're being very mindful around the deposits that we've brought in. We are increasingly confident that the longevity of those deposits is longer than initially thought. And what that means is that's affirming the asset sensitivity that we have, right? And so when that gets -- when the assumption gets affirmed, then you can start going out the curve and trying to match asset duration to that sort of emerging liability duration. So we have been adding swaps. Some of those have been forward-starting swaps. And as I said, we have been adding to the investment portfolio at, kind of, over $1 billion a quarter. And then maybe third and finally, we're thinking of creative ways to use this sort of deposit-driven cash position to be a competitive advantage for us. And you see that in the use of teaser rates and some of these core and targeted loan portfolios. So over time, I expect to work that asset sensitivity down, but it will be based upon sort of the ALCO Committee's determination of the longevity of those deposits.

Great. Paul, definitely appreciate you spending some time with us today and look forward to seeing you again in the future.

Great. Thank you.

Thank you.