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

All right. We're going to get started. Up next, James, you could join us on stage. We're excited to have Zions Bancorp in person once again. Zion has delivered best-in-class NII growth. Loan growth benefits from margin expansion need to manage credit and the [indiscernible]. Behind the scenes, the latest [ expected transformation ] for Q4, which positions Zion wealth to have industry-leading modern technology, which we look forward to hearing about. Here to tell us more about the story is Chairman and CEO, Harris Simmons. Harris is going to do a short presentation followed by a fireside chat.

Okay. It's nice to be with all of you. I'm going to go through a few slides pretty quickly and save as much time as I can for some discussion. I think a lot of you probably know a little about the company. Very Western United States focused. We operate as -- really, we try to have ourselves in the market as we call it collection of great banks to really kind of community banks like divisions or affiliates as we call them in major Western markets that are like really good community banks with local leadership, be a lot of -- all of the back office risk management, product management, et cetera, all very centralized. We are very focused on small businesses, perhaps particularly commercial, middle market and then the owners of those businesses. So an increasing focus on the affluent segment of our customer base who are running these businesses and building capital markets capability that we think should be very helpful in improving our fee income numbers. And then around the -- outside of this circle here, some of the local enablers we're enabling technology and areas of focus that help us achieve that technology, data and analytics, operational excellence, risk management and then just raising the quality of the people and their skill sets, including out in branches, out in the field. We're going to skip through that and just go right to deposit growth because that's an issue that I know is topical with a lot of you. We've seen -- as an industry, we've had an enormous amount of deposit growth through the pandemic. Total deposits in the United States increased by 1/3 over 24 months. Now we're seeing the flip side of that is draining money from the system. And we're seeing outflows. We have the luxury of having come into this with an enormous amount of liquidity, loan-to-deposit ratio today of about 71%, which gives us a lot of latitude. And we've had a deposit beta from third quarter of last year, the quarter of this year at just under 3%. That -- we would expect that, that will start to pick up as higher rates linger on for a while here and the Fed continues to hike a little bit. But nevertheless think that it's going to produce continued margin expansion. And we -- I'd expect that we'll continue to see some outflow of deposits before it stabilizes. But we started in our case, with $57 billion in deposits. We're up kind of almost $20 billion beyond that and seeing another $4 billion or $5 billion come out. It would still leave us net-net in a pretty good place and with still a lot of room for growth. If I go on to just looking at the composition of deposits and their cost. We have about 51% of the total deposit noninterest-bearing demand deposits. And it's a very granular deposit base and produces a lot of really sticky operating account money kind of at the core, and we've had this overlay of a lot of kind of -- if anything has been transitory in this world, it's probably been the deposits in the banking system. So we've seen a lot of this come in and it's flowing out. But we have about a good mix of deposits that you'll find in the industry. It led us to be able to price this very, very attractively. Over time, when we've had higher and been in higher rate environments, what we found is that our company has about a 40 basis point advantage in terms of funding costs or deposit costs over our peers. And we expect that, that will emerge as we get deeper into the cycle. This is looking at deposits by balance here and kind of what's happened here. What you see is on the left-hand side, these are accounts with over $10 million in total balances. And we had about $6.1 billion of attrition in those accounts from December 31 through the end of September. Like in smaller accounts, we've been pretty stable. Not a lot of -- actually a little bit of growth. And we would expect that we're going to have to become more aggressive again as rates continue to rise to really maintain that deposit base. But in the meantime, it's producing some really fabulous margins. If we look at the -- let's see. I think I'm going to go on to -- I'm just showing margins. I think I'm going to talk about rate sensitivity here for just a moment. We expect that over the course of the next year that we're going to see just what's kind of baked into both interest rate hikes that have taken place as well as the forward curve, a lot of 14% expansion in net interest income. If we look at the third quarter of next year versus the third quarter of '22, and we break this into what we call latent interest rate sensitivity. That's what is already baked in based upon rate movements that we've seen, but where there's a lag effect as loans reprice, et cetera. And then there's what we call an emergent piece of this which is really what we would expect to happen on the forward curve this September 30. And this all assumes about a 13 percentage point deposit bay, which -- and is north of where we've been more reflective of what we think the next year is likely to hold. So we expect that we'll see increasing net interest income this coming year, even absent loan growth. And any loan growth will add further than that. Loan growth net of any securities runoff. If we go to -- let's see, go on to -- just move ahead. These -- all these slides are on our website. I want to talk about just our adjusted pre-provision net revenue. And what you can see is that over the course of the last year, that if you could strip out the impact of PPP program where we had -- where we are a very large player, we've had about a 53% increase in PPNR and that's reflecting this margin expansion. We had in the third quarter of last year, this year during this period of a year, average deposits were pretty flat, but the yields on money market investments increased by about 231 basis points, deposit costs increased by 6 basis points. And that's really what's driving this really strong PPNR growth. I'm going to go on to talk about credit quality here for a moment. We are just not seeing yet any deterioration that's of any concern to us in terms of credit quality. We've had a very low net charge-off ratio over the last several years, typically down in the low single basis points range. You can see that classified loans have been trending down. Nonaccruals, nonperforming loans have been trending down. And we expect that the economy slows that this will probably tick up a little bit, but we think we come into whatever recession may await us in very good shape. The other thing we would note is that when you look at loan loss severity over time, we have a very highly collateralized portfolio. We're fundamentally a commercial lender at heart and most of the money we do is lateralized and that has been that. And I think quite good underwriting has been a factor in producing very low levels of charge-off. When we have a nonaccrual loan, we end up charging off about 11% of the average nonaccrual loan. And you can see the median and appear for something close to [ 40% ]. And so that's something that also we think bodes well as we come in any recession. I want to talk about capital for just a minute. Common equity Tier 1 ratio of 9.6% plus the median. I expect that will probably strengthen a little bit over the next couple of quarters. My hope is it would put us in a position if credit remains benign and the margin expansion where we'd be able to increase our share buybacks or we're in a position to be thinking about that. There's been a lot of focus on tangible common equity. We think because we have very heavy liquidity, I'll probably talk more about that, but -- and TCE, but that's not of [ particular concern ]. We're really focused on CET1 as a primary measure of capital. And then just a few things as we think about the year ahead. As rates have risen, we've started to bring our rate sensitivity somewhat closer to neutral. We're naturally asset-sensitive, and I expect will remain somewhat asset sensitive here over the next at least couple of quarters. But we're starting to increasingly protect against the downside of falling rates. We are continuing to see quite good loan demand. I expect that, that will probably soften at some point as the economy presumably slows a little bit. But our balance sheet composition really allows us a lot of flexibility, as I've discussed. And we think that we're in pretty good shape for a recession. And so with that, I think I'm going to take a seat and we'll have a conversation.

Great. And thank you for the prepared remarks there. So to kick off, you talked in the beginning about small business being your bread and butter, small business formation, particularly on the low end has been very strong since the latter part of '21. I know internally, you've set a goal to grow customers at a pace well in the business formation. Maybe just talk about how this initiative is progressive -- progressing and what this means the growth across the balance sheet for the bank.

Sure. One of the things -- I'd share it by saying that the PPP program was really a godsend for -- certainly for a lot of small businesses, and it was a really good thing for us in that we made about $10 billion in PPP loans, about 77,000 businesses and about 20,000 of those were new to the bank. Everybody that received a loan from us had to open an account. And so currently, it's actually -- what was a success turns in a little bit of a headwind because some of those accounts will not stick around. They had relationships elsewhere, et cetera. We've been working hard to make sure we keep as many as we can. But some of the attrition near [ retards ] our customer acquisition growth somewhat, but we're still seeing pretty good client acquisition rates. One of the things that we've been doing this year is having all of our -- we actually really try to engage our people in the branches. One of my objectives in life is to create fulfilling career opportunities for people who work out in the field, typically a branch manager or a business bank or people out serving customers. And one of the things we've been having them do is we've been asking to make calls to customers. And we -- just to thank them for their business. And we'll end the year having made about 100,000 just calls to help people thank you. And in the course of that, they end up discovering all kinds of opportunities to do business -- additional business customers. And that's something we'll be continuing, I expect, permanently. So I'd set up just arbitrary and highly aspirational goals. We were making that through the pandemic years that slowed off a little bit, but we're still seeing good customer growth.

So a big initiative of the bank has been the big tech formation. I think we're in about the tenth year. A couple of questions. Just what's left to do? What's the next step once the core deposit conversion is complete next year? And what should investors be looking at to judge success of this multiyear journey that you've had?

Yes. So this project, which we call FutureCore is something that we've been at for about a decade. And this is replacing core systems for both loans and deposits with what is called the bank's platform from TCS or Tata Consultancy Services in India. It is -- they've been a great partner. I think it's a really fabulous software, and it's integrated, which means that there are all kinds of ways that we expect that it will simplify the way we do business. And certainly, our ability to plug new applications and third-party products into our core environment about a lot of complicated middleware, et cetera. It will allow for real-time payments. It -- there are real-time systems. So when we post something to an account is showing up to be able to show up immediately across all of our channels. And so it's a much more modern platform than most anybody in this industry is running on today. Most everybody is running on 30-, 40-year-old core systems. And so for us, the good news, we think we're fundamentally a decade ahead of anybody who's starting to think about core replacements. One of the measures of success of this continue over the last few years. And last year, inflationary pressures and some internal growth that we've been going through and building out capital markets, for example, has created some cost pressures. And certainly, just the wage pressures in the market. But over a period of 10 years, our expenses have been growing at less than the inflation rate. And a lot of that has been because we've had to do a lot of house cleaning along the way that this project just portions. And so I thought people that a lot of the success of this project has already been seen and just what we were able to do to expenses. But going forward, we will -- it also has created some backlog of other things can -- this is a project that had hundreds of people involved and a lot of subject matter experts. And so we're working on backlog items that are mostly customer-facing in the course of the next year or 2. [indiscernible] spend to kind of stabilize a little bit, but it's not going to come down dramatically because there's always more to do.

So Harris, I get that you are a student of inflation so I think one of the personal opinion questions I'm asking on the day, but do you think the Fed has done enough to get inflation under control? And what do you think your view could mean for both the company and Zion in 2023?

I mean my personal opinion is, I think there's a pretty good chance the probability like that the Fed has -- is going to be a tougher, longer path than everybody like [indiscernible]. We see some kind of green shoots with declining prices, et cetera. Underneath all of this, it's still a lot of wage pressure and demographics that are challenging. And I think the Fed -- I've got to believe we're thinking about what happened in the '70s. In the fall of '69, they took the Fed funds rate up to 9.2% to battle inflation coming out off of the Vietnam war. They brought the rate down to 3.7% a few years later and it came rolling back. And so it took the rate up to 12.9% in the summer of '74 before bringing it down to 4.8% previously. Took Paul Walker to come along and take it up to [ 9.1% ]. And I think the lesson in that is -- and you're hearing people like John Williams are starting to say that they're going to have to stay at this probably longer than a lot of people might have thought. I -- it's not sort of a bet that we're going to make internally in terms of selling. We're going to review the assets. I think I would expect incrementally that we will be -- I guess, some of the benefit of that would also be in a position of better protectors as it outside of that business. But I think inflation is going to be around for a while.

Some of the in the knock-on [indiscernible] the take costs in the $1.6 billion to $1.7 billion range for almost 10 years, reasonably start to see it growing at NFS to face double digits in the past 2 quarters. Can you unpack for us what has been driving -- what have been the expense of cost increases, wage pressure, tech upgrades versus offensive hiring revenue you producing bankers and investing in selling [ parties ]? Where do you think expense growth is headed over the medium term? And what are the key drivers?

Yes. So some of the drivers for this, coming out of the pandemic we've had the recent [ branches ]. I mean we had a lot of branches running [ were just use ], for example. So there have been snap ads there. Cost of people generally this is really -- some particularly entry-level positions we found that we were having to do pretty significant increases. Technology, labor like cybersecurity and things like this have become pretty expensive. Building out, as I mentioned, in the capital markets business has added somewhat to the pressure. I think that I would expect going forward that as we complete this technology project, which will have -- we expect to cross the finish line here by September of next year, that will start to moderate some of the pressure. There's been a lot of -- as I mentioned, there's been a lot of attention by regulators on [ resilience ] and larger banks. And so we've been spending on disaster recovery and backup and those kinds of things. That's got some upfront component. So I expect that this will moderate somewhat. But as long as we've got inflation running hot, I expect it's going to be in the mid-single digits or maybe a little higher than that.

Just another thing that you talked about in your presentation was as this -- you showed a slide where attrition has come from accounts greater than $10 million. I think you said something like within the $4 billion, $5 billion of freight, higher rate or a low churn on the balance sheet. In your view of the economy, what do you think that means for funding for growth going forward? And then -- and where do you see deposits heading [indiscernible]?

Well, I think deposits are going to -- I think some of this kind of surge will continue to come off. I mean, there's an enormous amount of money supply that got distributed around the banking system, and we had our share certainly of that. Underneath that is -- I think it's just kind of growth that reflects growth in our markets, et cetera. I expect that we'll see some continued runoff. We'll need to start to raise rates on deposit accounts to really defensively to protect relationships. But there's -- it's all a matter of pricing. And I think we come into this with a fabulous deposit base and a lot of really good relationships with customers and ability to fund ourselves really well. I mean we could add $9 billion of loans today and still have a very comfortable loan to deposit ratio. But alternatively, we can see $10 billion in deposits run off and still be very comfortable. There's some combination of the 2. So we've got a lot of latitude. I don't see that being a lot pressure, but I also think people shouldn't panic with us or anybody else to see deposits running off. We weren't [indiscernible] to bringing deposits on. Yes.

Harris, you talked about if we're in a higher for longer environment, you need to create rates. In your presentation, you talked about base that said the number 13%, which is an all-in maybe closer to a 30% interest bearing data. Can you maintain those kind of betas in the higher for longer kind of environment? And what are some of the puts and takes that you're thinking about in your price?

Well, for one, I think it's really useful to look back [ to the last time you had the rate environment is what you think today? And that was probably before the financial price it had effect rate of about 5%. And in our case, ] we had half the demand deposit proportion than we do today. And we had a net interest margin that was 100 basis points higher. About half of that is probably -- would go away if we had the same composition of the loans and securities we do today. So we had a risk portfolio [indiscernible] 10 years ago, 15 years ago. But we think that apples-to-apples and that -- it had today's balance sheet back then. And we just had a 4% NIM. And so it's a reminder to me that you can have deposits coming from demand and other account types, et cetera. But generally, if you got a good core deposit base, some of higher interest rate environment is really a valuable saying for regional banking branches.

So in your prepared remarks, it sounded as if loan growth continues to be strong. I know you've had in the business in quarter updates. But maybe just talk about how you're feeling about loan growth maybe relative to [ year ago ]. I know that you've highlighted the municipal and owner occupied as areas of growth. What are areas where you're moving back in? How are you thinking about higher interest rates for a long period of time impacting [ one ] for your portfolio?

Well, I'll start by saying forecasting loan growth is such a fool's errand usually because I think almost everybody is just -- it's an inertial kind of what have we seen? And will that continue kind of thing. That said, most -- all of the markets we're in, it doesn't feel like things are slowing materially. And I expect commercial demand to probably continue to be pretty good. We expect the commercial real estate, we've been pulling back on that for some time. We've been kind of at the bottom quartile in terms of growth in CRE for the last several years. And that probably slows further 1 to 4 family that we put on the balance sheet, which tend to be a couple of arms. A lot of them are self-employed, the kind of owners of businesses, et cetera. You've seen that pipeline remain [ pretty ]. So I think that we're going to continue to see on [indiscernible] where we say, I like to kind of see moderate loan growth, we added all up, slowing somewhat with what the Fed is trying to accomplish. But I think it's going to continue to show through.

You mentioned commercial real estate, we had a lot of discussions about that today. You noted in your prepared remarks that you feel well prepared for a recession, which is good to hear. While you mentioned that you're not really seeing anything, can you maybe just talk about the areas of the portfolio or leading indicators that you're watching? And I know when Scott presented, one of the recent costs get numbers in charge-off. What does [indiscernible]?

Well, our charge-off numbers have been running as a couple of idiosyncratic last quarter. I don't think that that's going to be indicative of what we see in the next couple of quarters. And they've [ only have ] charge-offs in the low single basis points. I would expect a reflection that, that takes it up closer to something like that. I mean that would feel -- and all a matter of severity. But beyond that, I think that we're -- we've done a lot of derisking in our portfolio in the last decade that makes us feel like we can sleep pretty well at night.

What would be the areas that you would highlight as...

In terms of areas that might be higher risk, I think anybody -- the one area that kind of stands out, everybody is thinking about, which is office. And I think we've underwritten well everybody, banking sector, everybody has been that the rules changed. And so -- and it will take time to see that play out because you're going to have to watch this take time for leases to roll.

[indiscernible] With a couple more topics I want to hit on the last 4 or 5 minutes here. So for many years, you had said that you want capital to be slightly above the peer group. And if look now, your CET1 is roughly in line. However, if I look at the TCE, if I the chart together that James talked about, you would be on the lower end of peers, although you've largely handled by moving $9 million -- $9 billion held to maturity. Will this all impact the way that you think about capital, whether returning or just the level you manage to [indiscernible] as you potentially have [indiscernible]?

Yes, the TCE did that...

Did TCE impact the way you managing capital over?

Not very much. Next thing, we've now $13 billion of book value in the security with HTM. I'd say just currently, I mean, it's such a ridiculous account. I mean security is kind of a security. By moving it, you can still pledge, you can still repo it, et cetera. There's still a lot of liquidity value in the portfolio. Even if you make the HTM work in banks, even in some very large banks, if you add all of that, the [ HPI ] it takes tangible capital down pretty low. But anytime you mark, call it, 10% or 15% of a balance sheet, we have assets out of the balance sheet bank, which is 10:1 and don't do an offsetting mark on the liabilities or cutting it, you get worried things could to happen to anyone. And clearly, the core deposit franchises so many banks across the history have much more valuable and [indiscernible] in GAAP. And I think regulators are [indiscernible] they're saying, look, there's a lot of liquidity out there. Most banks are going to have to sell these portfolios. And we're not seeing a lot of consent regulators, and we're certainly not feeling concerned. The only concern would be if the optics of this got so bad that it created a natural reaction with people who don't understand what they're looking at.

So maybe in the last minute, [ I think a question here ], but curious if there's any change in thought. So we're close to the end of the [ cortex ] transformation. You've invested in all these resources, profitability to improve. But yes, obviously, we look at a potential downturn, so this is more of an intermediate oriented question. Does [indiscernible] factor into the equation at all in terms of scale and the size of the organization, what would we need to change? Or is there any fee income initiatives given that you mentioned you guys are building out capital markets, which, as we know, is a big [indiscernible]?

Well, first of all, I'd say that having a technology project to the size we find us can put us, I think, in a really good position in terms of being able to integrate [indiscernible] new deals. The reason to do deals, if the fit is right in terms of deposit base, pipeline they serve and whether it fits geographically, et cetera. So I hope that we get into a position where we start to think about that, but it's nothing that we -- I don't think we have to be bigger. I don't think size is really is the solution for any problems. That said, it can help if you have the right fit and the right [ place ].

Got it. Unfortunately [indiscernible]. Thanks, Harris.

Thank you.