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

As we continue, next up, very pleased to have Zions Bancorp from the company we have Harris Simmons up here, Shannon Drage from Investor Relations. I know Harris put out a slide deck on Monday. I don't think you can take us through that or just want to jump into Q&A?

We'll probably jump into Q&A. I think we had -- I mean it was the same -- fundamentally the same disclosure we had at the end of the second quarter, with the exception of the slide where we provided some kind of contemporaneous information on deposit trends and pricing and NIM, which I think everybody has probably found helpful, but I'm guessing a lot of people here have probably seen that. And I think we need to jump right in.

Jump right in. We'll get to that. I think it was Page 19 jumped out to me.

But I guess maybe we just start big picture before we kind of get into the financials. Obviously, franchises situated in the western part of the country, very kind of small business market focus. Maybe just talk to kind of what you're hearing from your customers given this high inflation, high interest rate on certain economic backdrop?

Well, I think if I go back a few months, maybe what's changing is what I think we were maybe hearing predominantly was a really tough environment in terms of finding labor. I mean just good help is hard to find, and they -- and everybody was seeing it in higher turnover and pressure on wages, and I think that's really changing. It's probably -- I mean it's still -- I think, labor market conditions still reasonably tight in the markets we're in, but certainly better than they've been. I -- we're seeing a real slowdown in loan demand. I suspect that's kind of a function of just higher rates. I mean, it's just -- we've got a lot of people running businesses that haven't -- that have never had to carry inventory or finance assets, that borrowing costs that might be 6% or 7% or 8% for small business. And anyway, loan demand has slowed, but things continue to feel pretty healthy. And certainly, it's reflected in credit quality and delinquencies in small business credits. Middle market is still looking really good.

I guess when you think about that segment, there's a chance they could be in this high interest rate environment for a while. At some point, do they just need to kind of borrow despite the fact that costs are elevated? Or kind of how long does this kind of slowdown last in loan demand, assuming kind of a -- kind [indiscernible] them along, albeit with high rates?

Well, I think if you put things in historical perspective, the rates we're seeing today are actually kind of the normal over the last 40 years. I mean, it was the last 10 years that was kind of the aberration. And so just my own supposition is that people may kind of adjust to the idea that this part of cost of doing business is financing. Inventory and expansion and going up, but it's going to be helpful to get beyond sort of this overhang psychologically is a recession around the corner, and so that's been kind of like the mechanical rabbit at the dog races. I mean, it's always just kind of 20 yards in front of us. It'd be nice to have a 20 years behind us.

It always seems to be lifting out. You kind of referenced kind of the slide deck, which you did show kind of monthly deposit trends. And one of the things that we saw is clearly kind of -- you did see deposit kind of growth with June to July to August after kind of a measured decline kind of earlier in the year. Can we talk to in terms of where is that growth coming? Is it kind of customers that diversified coming back? Is it new customers? Is it customers that are growing? And just maybe talk about your expectations around mix?

[indiscernible]. We have Shannon. She's done a lot of research into it. Just talk a little bit about that.

Sure. Yes. On the deposit side, what we're seeing here in the third quarter is sort of a continuation of our efforts that we started much earlier in the year to bring some of our customers who had moved off balance sheet for rate and to bring them on balance sheet. So they're coming back on to the balance sheet in competitively priced products, and we are seeing some return of customers who maybe left when tensions were high. And certainly, some new customers with more competitive pricing. We are seeing some new customer growth there.

And then in terms of the shift out of noninterest-bearing into interest-bearing kind of persists, I mean, I guess, any signs of that abating? And just how do you think that plays out for the -- in the near to intermediate term?

Well, yes, the -- I mean, if you were to kind of graph the change, it's -- the slope is settling out, and I expect it will continue. I don't know where the kind of the terminal value is going to be. Back in -- if I go back pre-financial crisis, which was kind of a similar rate environment. If you can get back about 2006, it's going back a ways. But it was a 25% demand deposits -- total deposits. Today, we're at about 37%, and I don't think it goes as low as it was then, and -- until and unless we see quite a lot of additional hiking in rates. But it's -- it will probably continue. It's a little like there's kind of low-hanging fruit or a lot of the obvious excess balances money, rate-sensitive money and demand deposits is left. And it will continue, but I think at a diminishing pace. But I'm not quite sure when it settles out, probably when rates kind of peak and start to come back down.

And then you guys were, I guess active users of brokered deposits over the last few quarters, assuming you kind of begin to roll those off? Or how do you think about that?

Yes. Those -- I mean, it was opportunistic, right, in the wake of what's happened at SVB. You're describing anything it could off the shelf to make sure you have a lot of liquidity, and it is running down at peak to about $8.5 billion is coming down. I would expect that, that will continue to run off as we kind of normalize and have both bring some of the balances that, during the surge in deposits, we kind of pushed off the balance sheet, bringing them on and other customers coming back. So that will come down to a much lower number.

And last, I guess, just given the improved deposit growth outlook, does that kind of play into all your kind of expectations and kind of where betas pan out for the cycle?

Yes. The -- again, in terms of betas, I mean, the Fed is slowing. They may be approaching something of peak, and I would expect that that's kind of where you'll see the same with betas. And so I -- again, I'm not -- I don't know where the terminal number is, but it feels like we're probably getting there. In terms of deposit growth, we -- I expect that this quarter will be another good -- this will be a good quarter for deposit growth as we continue to kind of rearrange the mix and bring some off-balance sheet money back on. And beyond that, the -- I expect that the balance sheet is going to be pretty flat. I mean, deposits have really driven the growth in recent years. But even before the crisis in March, as the Fed sort of tightening, I mean deposits were coming down. The Fed had flooded the industry with money, starting to pull back, and we're seeing that. I mean, Silicon Valley really accelerated that. But the -- and what I would expect to see going forward is that we're seeing weak loan demand, securities that probably will run off a little faster than incremental loan growth. And I think that will probably actually put a cap or even -- we could see a little smaller balance sheet going forward.

Got it. We're going to come back to that in a second. I guess the drop in NIM from January to May was, I think, greater than a lot of us would have anticipated. On the flip side now, improvement from May to August has been kind of outperformed peers. Maybe talk to -- maybe some of the drivers of that? And just how you kind of see that trajectory going into the end of this year into the next?

Yes. Well, I mean, there are a couple of drivers to it. First of all, we do have a lot of asset repricing going on. You have a -- as we've been bringing money back onto the balance sheet, it's been displacing higher costs, wholesale kind of short-term borrowing that we put in place, including even some of the brokered deposits right in the wake of SVB, and so all of that is playing out into a little stronger NIM. I don't know if you have any other thoughts about it, Shannon, in terms of what's any of the elements? But I think those are the major ones.

Yes. I mean I think you saw us have a pretty significant gap in terms of deposit -- total deposit costs appears prior to SVB. I think you've seen a lot of catch up there where we're kind of back to more of a historical norm relative to peers. So I think that, when you're looking at kind of that drop, we did have some catching up to do on the deposit cost side.

Got it. And then maybe on the expense front, one of the themes for this conference is third quarter expenses running higher than expected, which is a little bit surprising because you would have thought March, April events sort of made people tighten up a bit. I guess there's other pressures. And on the flip side, everyone's kind of talking about better expense management next year, although I think we heard that last year and is not happening. Just maybe talk about just overall expense management as you kind of begin kind of the 2024 budget process?

Yes. Well, we've been trimming headcount. I expect that we'll start into the year. A lot of this is actually in place as we speak. We'll come into the new year with about 3% reduction from where we were in the first quarter. And everybody, and I talk to our peers, everybody is looking for ways to cut costs. It is a -- one of the things I would note is, not to pin the tail on this, but it is -- I mean, the regulatory environment is a really tough one right now in terms of what is being asked to banks in terms of just resilience and controls. And a lot of that was in place before SVB, but that's exacerbated it. And so I look at our spend, I mean, many of you who follow us know who've been spending quite a lot to replacing core systems. But beyond that, a lot of what we -- a lot of the spend is really dealing with just really strengthening and fortifying the operational resilience of the organization. And a lot of that is driven by a regulatory agenda, which I think you're seeing around the industry. And it's -- and it's not something you can kind of just say, hey, we'll put that off. That's not an option. So that's driving some of the spending pressure, I think, with us and in the industry.

Got it. And then on credit quality, your losses have kind of been nonexistent. Yet every day, pick up the paper, there's always kind of concern on commercial real estate and office. And maybe kind of just update us in terms of kind of what you're seeing here [ from ] customers from a credit perspective? Where you're kind of most concerned about and maybe why we haven't seen kind of losses manifest themselves yet?

Yes. I mean the only area -- I mean, you're concerned about everything in an environment where as you see the economy slow potentially. The office segment in commercial real estate, it's about a $2.2 billion portfolio for us, and it's one that -- I mean, first, I back off and say commercial real estate, for the last decade, really coming out of the financial crisis, there are things you learn and say, okay, we're going to do something differently. And I think one of the things we learned, underwriting, as we came into financial crisis which I think was actually quite good. I think we've done that well for a long time. Concentration management wasn't. And we've got -- we had way too much concentration of construction, land development places like Southern Nevada, Arizona, and places that had some real challenges during the crisis. We came out of it and said the mantra was that commercial real estate is going to grow more slowly than the rest of the balance sheet, and that translated into some limits and some discipline that's actually is growing. I mean, if you look among our peer group, I think you'd find that we're -- we maybe in the bottom, maybe decile or so in terms of CRE growth, so over the last decade, it's grown at a rate of a little under 3% compounded. And so we used to be quite outsized, what I think we're back to approaching something closer to kind of the norm in the industry. If you're going to be in the West, real estate is going to be part of your game, but I do think that we have the benefit of having sort of a lot of kind of vintage diversity in the portfolio, and that brings with it amortization. And I think we have a really good underwriting culture in the company. On the office segment, that's about a $2.2 billion portfolio. And at present, I mean, if you go through that, I've got it name by name for at least the largest exposures. There's actually amazing strength in most -- I mean, there are a handful of names where we're really watching it carefully, but nonaccruals in that portfolio are about $16 million today. Criticized classified in the portfolio is under 5%, and it's not something that's really keeping us away. We got deals -- some of the largest deals, I was reading a list of among the 25 largest deals, just going through LTVs, loan-to-values on. It's based on the latest appraisal and that may have been a while ago, so with a grain of salt. But we've got numbers in there like 20%, 6%, 11%. There's 60%, 70% 40%, 23%. It's not like everything is margin to the hilt. There's really quite a lot of -- and so there's really quite a lot of strength in most of the portfolio, and then there are some names where they're repositioning an asset, taking something down to the studs and going to turn it into something else, or you're going to have some negotiation with borrowers that matures. But so far, I think just without exception, I mean, sponsors are supporting our deals. When we -- you have maturities, we've got about $436 million that mature this year in that portfolio. And the negotiation is you bring additional cash or we're going to raise the rate or -- yes. So it's -- it's so far working out, I think, quite well, and I'm not really excessively concerned about it. To the extent I'm concerned about any portfolio it would be that one. Multifamily is seeing some weakness in some markets, but again, not anything that we're seeing. And -- and it's something that we've kind of, again, I think had some pretty good discipline around over the last half a dozen years, which is going to help a lot.

So I mean, I guess, we read a lot -- it seems like every day in the financial press and articles saying office CRE is the next [ Armageddon ]. I guess, are those concerns maybe overblown? Or is it a major issue but yet, given kind of your focus on LTVs, maybe an issue as a whole for other banks, but not so much for Zions?

No, I don't think fundamentally it's overblown, but I think it's -- it gets very specific with respect to market and whether it's urban, suburban, the nature of strike the sponsor, et cetera. I mean, one of the really fascinating things about our office portfolio is a medium size of a deal is -- it sounds unbelievable. It's $900,000. The average size of the deal is $4.5 million. I mean we do a lot -- I mean there are a lot of -- it kind of reflects the small business is kind of granular. So I mean, there are -- a lot of these deals can kind of -- there are ways to work through it. These aren't 60-story high-rises in the downtown L.A. that we're financing, so.

Good point. Good point. There's been a lot of new regulations come out in the industry over the last month or so. I appreciate that you're closer to $90 billion and $100 billion. But I guess, do you -- how do you kind of think about the [indiscernible] or long-term debt or some of these liquidity stuff coming out? Did that have any impact on you?

Well, it will. We expect it will have probably 4 to 5 years before it actually will kick in for us. So others will -- it will be -- it will be phased in. For us, the phase-in will actually be -- it won't be -- it will be more abrupt, but sort of the same ultimate timetable, sort of. I mean we're probably at that a little further. But yes, I mean we will start to prepare for that. The preparation maybe entails, if you had the fees, you got the right data definitions, et cetera, to meet the requirements. And that's where a lot of the kind of internal heavy lifting happens. And I think it's going to be manageable. I mean it's -- there will be a big project work effort around it, but doable. I mean a lot of the work we've been doing on core systems replacement, I think, is actually going to be helpful because it's forced us to go, clean up a lot of -- you got kind of clean the house and the closets for you before you convert some of these big core systems, deposit systems, et cetera. And so I think that is the ground work for lot of what's going to be needed. I mean the impact on the capital side, we think it will be incremental. I mean, primarily probably on the operational capital piece. I'm not sure that -- I mean, we'll have to see the final proposal and estimates but I don't -- our notion for the moment is that it's not going to be particularly punitive given the construct of our balance sheet. The operational piece will -- that will be a new element, and -- but we've managed through it. The debt piece is going to be -- that's just the tax on size. And I think they're fixing a wrong problem, but that's for another day.

I guess we had one bank, another $90 billion or so bank yesterday, make the comment. They don't want to -- probably not a good idea to triple over the $100 billion market but go through it, I think if you have the exact quote with a punch or something. Implying maybe we see more consolidation at the lower end, and you're better off getting $290 billion bank together as opposed to crossing it one afternoon. And I know we've talked a lot about kind of scale banking in the past. I guess, maybe any thoughts around that?

Yes. I mean, I think I don't agree with the premise of it. And for the following reason, what comes with $100 billion now is going to be this new capital regime and long-term debt requirement fundamentally. I mean, resolution planning thing is -- I don't think that's a huge deal. I mean it's doable once you develop, once you have done an amazing amount of change going on all the time. I mean once you get the template there, it's -- you keep refreshing it. But the capital and the debt pieces are fundamentally going to be variable costs, and so I'd take the debt piece. It becomes -- for most banks, the constraint will be 6% of risk-weighted assets. So if you're $100 billion, just to make it easy, if you've got $100 billion of risk-weighted assets, you're going to have $6 billion of debt. If you double your size, you're going to have $12 billion. And so I'm not sure -- I think in economies of scale, I think of fixed costs that you can spread over a larger base. This is a variable cost, and the same with the capital charge. I think you have even the operational piece of it. I mean you've doubled the size of the business, and fundamentally, your capital is going to double. And so I just don't think that this -- I mean, there may be other arguments. As we've talked about before, I'm not sure I'm not persuaded that they're all that real. But I don't see in the capital and the debt piece and economies of scale argument because they're variable -- fundamentally variable costs.

Makes sense. I want to follow up and see if there's questions from the audience, like I [ folded ] in the last presentation that we didn't see any questions. There's any?

With all the weather news coming out of the last -- this year, too much rain in one area, not enough rain in another, how are you finding both your customers reacting and your own lending practices and policies to adapt to -- but we shall see, whether it's a fundamental change in the environment or an [indiscernible].

Yes. Well first thing I'd say, we had the best snow year we've had in years, which was -- if that repeats this year, it will be actually phenomenal. We've been kind of in a long-term drought. The Hyatt Hotel in Downtown Salt Lake City actually had like a thermometer thing up the side of the building showing the snow depth. It went up to the -- almost the seventh floor. They had 900 inches of snow cumulatively up, but all the [indiscernible]. So that -- which created a little bit of what looks like flooding, but it was fundamentally great. But the better answer to the question is that the drought -- water -- the big issue in the West is really water availability. You read about whether it's the Great Salt Lake, which has been kind of a concern that it would just dry up, Lake Powell, Lake Mead are way down, and those are very real issues. For most -- in terms of direct impact on borrowers, I mean, we have an ag portfolio in places like Idaho. It's not a material part of our business, and it's something that you're able to kind of watch year-to-year. I mean, we're looking at borrowers, water rights, the seniority availability, all of that goes into the underwriting process. I think the larger issue in the West is water availability. My own belief is that all of the issues about climate change aside, which I personally believe are very real and something we need to be attending to, but it's not something that as an organization, we're going to solve. We need to kind of be responsive to it. But the fact of the matter is that about 70% of the water in the West, the Intermountain West at least, is used for agriculture. And in a place like Arizona, over time, as you've converted cotton crops into residential neighborhoods, for example, it turns out that people use a lot less water than agriculture does. And so there's fundamentally water supply, it's just how it's used in getting -- I personally believe that we have to let the market work and sort that out. You have to let those who own the water rights be paid fair market value and sort it out. There's probably too much agriculture in some parts of the West, given the water intensive nature of it, but I don't think that's going to have a lot of direct impact. It will have some -- to the extent local governments don't get it sorted out, you'll have a moratoria on building, and that can affect population growth in migration, the housing prices, et cetera. But it's not kind of on the top 10 list of what I worry about.

Any other questions? I did have an e-mail question, Harris. But the question was on your kind of outlook slide for net interest income, you still have stable to slightly decreasing when we think about 2Q '24 versus Q2 '23. But given the trajectory of an AI over the last few months, at what point does that switch to kind of slightly increasing or whatever kind of...

I think we fundamentally -- I mean, we left the guidance alone. As a general rule, we're not going to be changing guidance intra-quarter, so we'll have a discussion about it once -- when we get third quarter numbers. We'd like to have at least one more data point before we start changing what we said a couple of months ago. So I'm not sure that two additional data points is going to make a trend for us yet, but so far, so good. I hope it's promising enough that we'll be able to say something more sanguine, but -- as I said typical to I think the -- you've got some countervailing for -- yes, the margin has been improving. But I also think you're going to have pressure on balance sheet growth, which isn't a bad thing necessarily. It's just rightsizing the balance sheet. Balance sheets really grew as you have the -- deposits in the industry grew by 1/3 over 24 months during the pandemic. And that's not just -- that's not natural. So I think kind of there's a rightsizing that takes place, but that will probably keep earning assets flat to maybe even down a little bit even as its margins, I hope, continue to improve. But -- so I think we've got a little more sorting out to do before we're going to change the forward guidance on net interest income.

All right. And I guess on capital, kind of Tier 1 ratio continues to look good. I guess given the kind of the unrealized losses TCE, maybe a little bit slower than peers. How do you kind of think about that particularly in a world where you're kind of at some point moving where kind of it [indiscernible ] away for CET1?

Well, it's going to be a reasonable -- for better or worse, our situation will have the virtue of reasonable predictability, and that we moved a big portion of the portfolio and HCM back in the fourth quarter of last year and locked that in place because I said like if Fed's out of control, I think we can live with this particular number. And so our forecasting on this suggests that over the next 4 years, most -- the lion's share that will be gone, and we'll have some new rules that will inform kind of the duration and the positioning of securities on the balance sheet. And so we think it's going to be quite manageable without really impairing what we're doing with dividends and even some probably moderate kind of buybacks if we perform reasonably well. So we're going to have to do some additional math to really understand kind of when the NPR is finalized and we understand the new rule book. But from -- the broad outlines of what we see so far, we think we'll be in pretty good shape 4 years from now when it actually becomes effective for us.

Got it. Any other questions? One thing that I kind of skipped over when I was kind of running through the income statement was fee income. I know that's an area you're trying to build out. Maybe you want to provide us some updates on some of the kind of the key initiatives there?

Yes. Actually, you want to talk about fee income here?

Yes. I mean, this is definitely an area we've continued to focus on. We have a couple of businesses that we're continuing to invest in and grow. One is wealth management, where we feel like we're a little underrepresented there. So we've had some really great growth. We expect to continue to have growth there, kind of regardless of market conditions. And then the other capital markets, another platform we've been investing in, and we're seeing strong growth there. And sort of those investments and that continued growth -- continues to offset any headwinds we see in other places. We have some headwinds with treasury, sweep fees of -- clients that have now moved on balance sheet, customer kind of ebb and flow. But I think you'll continue to see us have a pretty nice growth trajectory.

Got it. Any final questions? If not, please join me in thanking Harris and Shannon for their time today.

Thank you.