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

All right. Good morning. Welcome to day 2 of the MS U.S. Financials Conference. We're delighted to have with us today from Zions, Scott McLean, President and COO; and James Abbott, Head of IR. Thanks so much for joining us.

Thanks, Manan. Thank you.

So Scott, James, maybe let's get straight to it. We saw the new deck last night. So you revised down the 12-month forward NII guide from moderately decreasing -- the decreasing and that you also expect NIMs to be in the 2.85% range for 2Q '23. Can you just speak to that and maybe speak to the drivers of that change?

Yes. No, happy to. And before we start, I just want to express our sympathy for the loss of Ken Zerbe, and -- he was a wonderful colleague. I know for all of you all and having traveled with him many times in Europe to see investors. He's just was always a good friend and a wonderful professional in every way.

He was wonderful individual.

Please accept our sympathies for his loss. Yes. So the 8-K yesterday, let me provide a little bit of context on that. Recall that in January, our January earnings call and our April earnings call, we said that we would be getting more aggressive with the pricing of our deposits. And then with the March volatility, that certainly made that strategy that we have stated even more important. The other side of that, though, is that, that approach to more aggressive pricing certainly has an impact on the net interest margin. And recall that in our April earnings call, we said that the net interest income would be down about 7% in the second quarter from the first quarter. And that at March 31, our spot NIM was 3%. What we're now saying, having seen 2 months of the quarter is that we think our NIM for the second quarter average will be about 2.85% for the average for the quarter. Deposit costs right now, interest-bearing at 3.31% were about -- we're 1.63% spot cost of interest-bearing deposits. At May 31, they were 2.43% and the total cost of deposits, spot cost at May 31 was about 1.4%, up from 0.9% at -- spot at 3.31%. So that -- those are the basic fundamental changes. And that caused us to reduce our guidance for moderately decreasing to decreasing.

All right. Perfect. So maybe to dig down a little bit there. You noted in the deck that there could be fluctuations in the mix of NIB deposits, can you speak to how you're thinking about the mix shift between NIB and IB, I think it was at 45, 55 at the end of 1Q. So maybe you could dig a little bit on that.

Yes. The mix of noninterest-bearing to total deposits, we've been an industry leader in that regard for decades. And it's not accidental, it is related totally to our strategy and our focus on banking small- and medium-sized businesses. This outsized noninterest-bearing tradition that we have is a function of many small operating accounts for these businesses. So -- they generally are not as rate sensitive because these small- and medium-sized business owners are -- they're more focused on their top line than making an extra 50 basis points on a $50,000 balance or a $75,000 balance. So even if you go back into the 2008 time frame and before, we've been top quartile and generally top of the charts when it comes to the mix. So it's difficult to know where that percentage will change. We're in the mid-40s right now. We were as high as 50, low 50s, which is really strange, quite frankly, when you think about our industry. And so it's certainly come down and will be influenced by the higher pricing that we're doing. But the one thing we're really confident of is, just like in the previous decades, the basic tenants of that deposit base are the same. They're the same type of customers, same type of operating accounts when it comes to noninterest-bearing balances. And so if rates continue to go up or there continues to be a shift, we think we will continue to maintain this competitive advantage of the percentage of noninterest-bearing balances to total as we have historically.

So one of the questions I get is, people look back to 4Q '19, sometimes look back to precrisis, you have a great chart in your deck showing the NIB percentage over a long period of time. Do you think that the '08 mix of 25% of NIB is reasonable baseline? Or do you think it's hard to get there given where you're starting from right now?

Well, a lot's happened since 2008. And in 2008, our mix was in the mid- to high 20s, our peers -- most of our peers were in the high teens, low 20s. So that competitive advantage was there. I don't think it could get back to that level simply because we've had 2 serious quantitative easings, maybe even 3 depending on how you measure it. But -- when you think about all the cash the Fed put into the industry and into the markets following 2008 and then again in '20 with some liberal support throughout that decade, really I think, pretty difficult to get back to a percentage that is there was.

And as we think about the deposit mix between NIB, IB broker deposits, the sources of funding, I think you put on about $5 billion or so of broker deposits in 1Q. How are you thinking about that mix as we get into the rest of the year?

Yes. And so 1Q was an interesting quarter. I mean it was a pretty normal quarter for 2 months and then the volatility in March was interesting for everybody. And so you saw that increase in broker deposits. And I would think most investors, as they watch us go through this cycle, we'll appreciate the flexibility we're showing not in -- both in terms of how we're creating this funding, but the cost of it. So broker deposits was certainly one lever we could pull, reciprocal deposits is another lever we can pull; both of those, along with just our higher-rate sweep accounts for large clients. All 3 of those will ebb and flow and -- but they all provide a very stable source of funding, number one. And secondly, they give us an opportunity to trim cost off of just wholesale borrowings overnight wholesale borrowings. So it's both those 3 types of accounts allow us to manage that overall cost better because those are lower-cost options generally. And they ensure that we're always having the stable funding we've always had.

Perfect. So maybe to just summarize the decline to 2.85% in NIM in 2Q '23, primarily driven by deposit costs and a little bit by the mix shift as well, but primarily as you get more competitive on the deposit side.

Right. And that's an average for the quarter. .

Correct. And so I guess as we think about deposit betas, I think you're about 27% all and you mentioned in the deck, you noted that the cost of deposits is up to about 1.4%. How should we think about through the cycle betas from here?

Deposit betas is -- I think it's a really interesting topic for analysts and for some really sophisticated investors. I think most investors, particularly long-term investors, look past betas and look at what's the real underlying source of deposits. And that would just take me back to the comments I made about this orientation to banking small and medium-sized businesses and what an advantage that has been for us over the decades. As for where betas might go, they probably will go up, but it just depends entirely on interest rate environment. So everybody is going to have to make their own assumptions about that. The one thing that investors know about us, though, is that you go back to any -- well, you go back to periods of rate increases, interest rate increases that most people would think about. And in almost every one of those, our beta was less than our peers. The period of time it increased and the ultimate beta was always very competitive to our peers. Again, this gets back to this client base that we have.

Yes. So I guess the granular deposit base helps you on a competitive level versus the other banks?

I mean Manan, that's one of the things that we've shown in the Slide 2, where we go back 20-plus years and say, what's been our competitive advantage. And how much has it been? And so we said anything above when Fed funds is above 3%, what has been the cost of deposits advantage for Zions. And it's been about 40 basis points. Whether you look at cost of funds or cost of deposits, it doesn't matter. It's about 40 basis points. Can't say that it would be speculative to say it will still be 40 basis points going forward because things change, right? Technology changes that allows people to move money faster and seek the best rate. But at the end of the day, to Scott's point, most of these small businesses that we bank, and there's over 200,000 of those, are not worried about getting an extra 10 or 20 or 30 basis points. They're worried about the relationship they have with their banker that's got some cool data on the desire for small businesses to have a relationship and to have a branch. It's actually pretty cool data. But that's what they care about. It's not that extra 10 or 20 basis points.

So maybe you can talk about that. The deposit base is fairly granular. We're also you know, now 3 months -- it's been 3 months since the bank failures, rates are at 5%. I mean, how much low-hanging fruit is actually there for deposits to move out of NIB into IB or these IB deposits to reprice?

Yes. I -- it's -- again, it's hard to say. It depends on what happens with interest rates. But our noninterest-bearing balances, again, have just shown much greater resiliency than that of our peers. And we don't have any reason to believe that will be different this time. What we do think we'll see, given what we communicated in our January and April earnings call, is that our customers by and large, are happy to have their funds on our balance sheet. We went through the '20 and '21 time period where we were -- because the industry was awash with deposits. Our deposits were up 35% in that 2-year period. The industry was up about 30%. And so we were encouraging customers to move their deposits off balance sheet. We had at 1 point in time, $12 billion of client deposits off balance sheet in sweeps. And things changed in '22 and early '23. So we're bringing those back on. And so when you talk about the change in interest-bearing deposits, I think given our strategy and the relationships with our customers, you'll see deposits being stable, certainly relative to the March time frame and growing as they come back on balance sheet. The cost will be higher than what we paid before but it will be less -- should be less than overnight borrowing.

All right. Perfect. And I do want to get into the asset side and how you're managing the securities as well. But maybe just a last question on the NIM. As we think about NIM being at about 2.85% average for the quarter for 2Q, how should we think about NIM going forward as it relates to your guide for decreasing NII going into 1Q '24?

Right. So what we said in the April earnings call was that the NIM in the second quarter would be down -- net interest income would be down about 7%. And that was -- it was a 1-quarter view that would lead into a 12-month view. That's where the moderately decreasing was coming from. And so I think most people would interpret our use of the word decreasing as it relates to net interest income. I'll let you back into the NIM would be a percentage at about that level or maybe even higher over this next 12 months, again depending on the -- what happens with interest rates. .

So maybe the other side of that is the earning assets. Loans are a big part of that. As we talk to other banks, a lot of banks are scaling back a little bit on loan growth, tightening lending standards. Can you talk about what you're doing in this environment?

Sure. We -- so we saw about 3% loan growth in the first quarter. And we're not giving any guidance on that in the second quarter, but we're coming off of 5 really terrific quarters of loan growth. The 5 quarters before that were over the pandemic period, and loans were pretty flat during that period of time. But we've had 5 really strong quarters. And so it's going to moderate from that. And -- we think that's appropriate given the increase in interest rates and the possibility of a recession, you pick what kind of recession. Investors should expect and we should expect loan growth to moderate. And you particularly see that when you think about commercial real estate lending, that's going to be soft for the industry. And we have -- our commercial real estate portfolio is pretty much flat in absolute dollars to where it was in 2008. So we've shown a lot of discipline on CRE, where most of our peers have actually had pretty significant increases in CRE over this period of time. That's going to be soft. 1-4 family mortgage has been a good balance creator for us, and that certainly has softened in the economy. And so I think the natural -- some of the natural drivers of loan demand, and then C&I is the biggest part for us, it's 50%. I think business owners are going to be -- they're in a watchful state right now, whereas the previous 5 quarters coming out of the pandemic, they were happy to get back to work and get in a forward-leaning mode.

So what is that -- it sounds like it's more a function of demand rather than supply across the industry. Do you think standards also tighten as we go forward given the higher cost of funds?

Yes. I think standards -- we maintain really high standards throughout all periods. But as rates have gone up so quickly, you would naturally adjust your underwriting. And as you think you're going into a recession, you would naturally update your underwriting. But I think going into a recession, just kind of big picture, I think most people are worried primarily about initially consumer unsecured. That's kind of the first thing that goes bump in a recession usually. And we don't have very much consumer unsecured. We're not the consumer unsecured bank, okay? A lot of people would look at construction lending. And we have about $2 billion in construction loans. It's less than 20% of our commercial real estate loans, 80% of our -- about $12.9 billion in commercial real estate is in term loans. And so anyway, we don't have a lot of construction. We have virtually no land loans, about $200 million in land loans, which compares to $3 billion in 2008. So virtually no land -- those are all categories that most investors would look at and express concern about in addition to leverage lending, which I think Moody's is going to put out a report here fairly sometime later in the year as they did a few years back, and I think most investors will see that we've been conservative on the leverage lending front as well. So the major areas where you would be concerned, I think we screen really well and our underwriting -- so we're not having to make a lot of underwriting changes in those regards.

So I do want to touch on credit, but maybe before that, just to round out the conversation on the balance sheet. How should we think about the securities book? And it feels like that the duration on the deposit side is moving lower, that you could have -- there's a potential for more regulation as well across the entire regional bank space. So how do you think about that? And how does that inform your view on how you manage your securities book?

Yes. So the securities book is about $25 billion today. It is virtually all government securities, highly liquid, easy to borrow against if you need to do that. And the cash flow out of that portfolio is about $3 billion, plus or minus right now a year annually. And so that's coming off at 2% rates, and it's going back in at higher rates. This is part of the asset repricing that I think many investors are not really focused on. They're really focused on the cost of deposits, cost of interest-bearing net interest-bearing mix, but everyone sort of hadn't really turned their attention to what's happening on the asset side. So we'll see a natural repricing in the securities portfolio, and we'll also see a natural repricing in the loan portfolio and -- which we have disclosures about that. But deposit costs are not the only thing changing right now.

I was just going to say, Manan, as we think about the size of our securities portfolio, it's several billion dollars higher than what we would normally run the size of the securities portfolio proportional to the balance sheet. And so we can probably -- at least the current plan is to allow the securities portfolio to decline several billion dollars and that will pay down borrowings. So it's -- you've got money coming off at 2% yield and paying off borrowings that are 5.25%, that's a huge net interest margin or net interest income expansion sort of situation. Loan yields I mean I think everybody knows where the Fed funds rate is today. Our loan yield was only 5 basis points higher than Fed funds. If you think about that in the first quarter, that's not where we book loans. We don't book loans at Fed funds plus 5 basis points. It's closer to about an 8% yield on loans. It's probably 7.75% or give or take. So the whole loan portfolio really sat substantially higher over the course of the next several quarters. The deposit situation has been a hurry up sort of situation, and that's been much more accelerated, thanks to the events of March. But I think after -- there will be a gradual improvement over time in that front.

So it sounds like just given the pace of the rate hike cycle, the deposits have been catching up a lot faster yet to reprice securities, yet to reprice. And you mentioned over the next several quarters, I think you also mentioned about $3 billion or so running off annually from the securities book. How do you think about reallocating that back to securities versus allowing...

Well, I think I said it, it's -- we have the option to either buy securities at higher yields or in similar duration, we're not changing our duration outlook really, or to pay down overnight borrowings. So -- and which are basically the Fed funds rate.

Got it. Okay. Perfect. And then just as you think about regulation, there's increasing conversations on regulations increasing for midsized banks. How are you thinking about that? What are you hearing from regulators?

Yes. I -- it's really hard to speculate. We have a very close relationship with our regulator, and it's impossible to know what exactly they'll do and what the overlay will be. I will say, though, that if you think back, we were the smallest of the SIFIs when SIFIs were a thing back in the '08 to '12, '13 time period. So we're pretty battle-tested on the large bank regulatory regimes and risk management practices. So that's something we actually won't -- it's not really a new thing because we never stop doing it. As it comes to capital, though, I think this is a pretty misunderstood concept right now. Our regulatory capital, common equity Tier 1 at about 9.9%. We are well capitalized based on the regulatory regime that exists today. There's been a lot of focus on tangible common less, which is less AOCI. It's less marks to the loan portfolio, et cetera. And I understand why people are focused on that. But if you look at -- to your question about regulation, if you look at the regulatory capital ratios that the global banks have, they -- it's basically CET1 minus AOCI. Okay. On that basis, we're at 5.5% today. And if you assume there's going to be some phase-in period, which is hard to imagine there wouldn't be over, let's say, 3 years, you can do the math with the disclosures we've made on AOCI accretion and earnings and any kind of recession overlay over a 3-year period. And I think most analysts will conclude that the growth in our regulatory capital on that more rigorous global bank basis will be way in excess of -- well in excess of the well-capitalized construct that the regulators have.

And it sounds like the regulators have made it pretty clear in their reports as well as in their testimony that there will be a long phase in period for any regulation that come in.

And it doesn't even need to be real long. I mean literally, if you just use 3 years of AOCI accretion and any conservative earnings accretion you want to think about with maintaining the dividend, you're going to see that our regulatory capital based on the global bank formula is well in excess of what the regulators call well capitalized.

Perfect. So I'm going to go to the audience for a quick question or 2 before we have to wrap up by 8 a.m. But just to round out that conversation on capital, you mentioned pausing buybacks at earnings. It's pretty consistent with what the other banks have done. Can you talk through that decision and how you're thinking about capital return in this environment?

Well, we're always thinking about capital and the return on capital. It's a terribly important concept. And we've had significant buybacks over the recent years. And so we've shown a willingness to trim. We always want to maintain our capital though. We said this for quite some time at or above peer average, okay? And so you'll see us continue to do that. But in this period, it's just logical that we would pause buybacks. And in that environment, you're going to see us accrete capital, I think, at a nice pace.

All right. Perfect. Are there any questions in the room?

If no one is asking, I'll just keep asking questions. So do you think we're -- I'm a credit investor, but do you think given where the equity has traded, that the goal is to just merely show that you are a strong bank, you can build capital and watch the revaluation of the equity in the capital stack as opposed to hurrying to do a capital return?

That's a great question. And that's really what I'm trying to say is that if you -- even if you look at us more conservatively with the global bank capital requirements and you look at any phase-in period that's not very long, you'll see us accrete capital to where we're well in excess of well capitalized. So to your point, there's no hurry to do anything other than just stay really close to fundamentals.

And I'll ask you, I think, a fairly straightforward question. In the past, you have been, I guess, hold into the Fed and the FDIC through. Do you have more constituents now that you have to keep happy in terms of your balance sheet.

I'm not sure exactly what you mean by beholding to the Fed or the FDIC but...

You march to their tune, right?

Well, we march to everybody's tune. We principally march to our investors' tunes.

Equity investors or credit investors?

Equity investors.

Okay. Do you have to march to credit investors now and depositors?

Well, let me just -- I appreciate the question. I think there's no one approach that ever works, okay? We have to, through the cycle, stay focused on equity investors. We have to stay focused on those that have more of a credit perspective because you have to manage credit well, which we have absolutely done through many cycles. You can go back many years and see our credit quality stats screen very well against our peers. And we're coming off a period of almost 0 -- sorry, almost 0 charge-offs. So whether it's equity or folks that are more focused on credit or regulators or customers or communities, we have a whole many dimensions that we have to balance. Thank you for those questions.

And maybe in the last minute or so we have here. Can you talk about with all the noise into March, what thought of this [ own ] story of investor is missing?

Thank you. Yes. I think first is this capital question, will we need to raise capital? And again, I think anyone that does the math will come to the conclusion that no, Zions does not need to raise capital. I think there's clearly a discount in our stock related to that. And at some point, investors have to decide, okay, we can see that and that discount should go away. Okay. Second thing is on deposit costs and asset repricing. We've tried to provide a lot of disclosure on that. And I think folks can model that. But this fundamental relationship, competitive advantage of our noninterest-bearing mix. Again, it's not accidental. It is core to who we are. Risk management, I think, is the third area. And -- and that's one where we kind of needed some downturns to really demonstrate that fully, but I think investors will see, particularly through the ways that I described being very conservative about commercial real estate, repositioning our loan portfolio since 2008 in a dramatic way and approaching loan growth responsibly. I think they're going to see our risk management practices are really strong. And then finally, so much of the value -- a lot of the value in our company is this deposit franchise. And I think folks will see that through different rate cycles as it has in the past, it will stay a competitive advantage from a valuation standpoint.

All right. With that, we're out of time. Scott, James thanks so much for joining us.

Thank you, Manan.

Thank you, Manan.