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

We're going to get started. Just to make sure my microphone is on. Up next, we're pleased to have Zions Bancorp joining us. again at the conference. Zion has now navigated a challenging environment, well by maintaining a tight control on expenses, move quickly to shore up its funding. And maintain a strong capital ratios. Here to tell us more about the story is Chairman and CEO, Harris Simmons, Harris, you're going to walk through some slides and then we're going to get into a discussion.

Yes. I'll briefly go through a few slides and then try to get to questions as quick as we can. A lot of you know us. We operate under local brand names as -- actually kind of as a publicly traded national bank. We don't have a holding company, but have actually a reasonably simple structure, but we operate with local brand names in markets across the West from Texas up to the Pacific Northwest and everything south and west of that. About $87 billion, $88 billion in total assets. We had very good credit results in recent quarters, and that's holding in well, largely a commercial organization, very commercially oriented. And I think we have a really fabulous franchise, particularly with a lot of small and midsized businesses. You can see here what's happened with average loan deposit balances over the last few quarters. Loans been growing, although that's slowing quite a lot recently. Average total deposits. You can see in the first quarter took a big dip. It's recovered nicely from the SVB crisis, although at a cost as we've seen across the industry. Ending deposits and again, some of the same kind of information, but you can see that -- and we repaired kind of an immediate hole with a lot of deposit flight from very large depositors with broker deposits and borrowings. We've been now paying that down and expect that to normalize here as we get into 2024. The total customer deposits include about $6 billion today of reciprocal deposits. One of the mechanisms we use to try to bring deposits back on balance sheet. If you look at net interest income, it was adversely affected by this, what we thought was going to be a very nice 2023 with very predictable building deposit beta was -- we had kind of a step function change in that in March. And so that's impacted margins, but it's stabilized, and we expect that month-to-month, quarter-to-quarter, you'll see some variation, but we think we're in a pretty stable place right now. If you look at the fee income, it's been reasonably stable. We're seeing some growth in wealth management, capital markets or some areas that we're focused on. Total revenue is down because of the margin compression. And so we're currently running quarterly adjusted revenue, taking out unusual items, about $765 million. Expenses, we saw some increase with coming out of the pandemic, higher labor costs, et cetera, but we've been working to keep that reasonably flat. We think it will be pretty modest growth in 2024. We've reduced head count by about 3% here in the fourth quarter, and that will be helpful as we come into the next year. Credit quality, as I mentioned, is in very good shape. We've seen a very slight tick up in nonperforming assets, classified loans, et cetera, but nothing that really moves the needle and charge-offs have been really well behaved, and we expect that will remain the case here in the next over the near term. We've been building the allowance. We're up about 1.3%, which relative to charge-offs is, we think, a reasonably conservative place to be. A lot of questions in the industry today about commercial real estate, about office in particular. The total portfolio is about $13 billion. Office is about $2.1 billion. And so far, so good. We've had less than $5 million in net charge-offs in the office portfolio so far this cycle. And we think that's -- we don't see that getting out of control anytime in the immediate future. I think it's going to be -- it's going to take a couple of years to really understand the office story. But it's not something that's really keeping us awake at night. I think with that, we will jump into some questions. So...

Thanks, Harris. Maybe to just jump in, I think you said 2023 didn't really end up playing out the way that we think. Most of us expected when we were sitting here last year. So as you look back on the events of the year, what are some of the key lessons learned? And how is it impacting the way that you run the bank going forward?

I think we absolutely came to appreciate the importance of planning and preparation. I think in terms of liquidity, I'm really proud of what we did. We were able to quickly replace some of this immediate large deposit departures with -- in the repo market, we were -- had a lot of collateral pledged at not only home loan, but the Fed. We tested lines. We were we were able to repo securities and so liquidity was never an issue. I think it made us appreciate the importance of doubling down, refocusing on smaller businesses, middle market, smaller middle-market kinds of businesses, of operating accounts, the granularity of the deposit base became really important, and the value of it becomes clearer as you go through an experience like this.

So you mentioned refocusing on small business. Small business activity has obviously slowed a decent amount over the past few quarters. Can you maybe talk about what you're seeing from your small business customer base in terms of activity and their willingness to borrow?

It's really slow right now. I mean they -- I think they're being really cautious. I think it's a function of rates, higher interest rates, spending down cash and just they've been reading about the looming recession for a couple of years. And I think it's taking a toll, concerns about consumers, savings, drying up, et cetera, et cetera. So for whatever reason, it's probably all of the above, we're not seeing very robust demand -- borrowing demand.

I guess more broadly, when you think about -- I think the last time we heard they were talking about something like relatively stable. Maybe just as you think about across the portfolio over the next 4 or 5 quarters, what are some of the puts and takes? Where are you actually seeing opportunities? And then second, what would it take for you to be a bit more upbeat on the lending opportunity?

Well, I think -- where are we seeing opportunities. Fundamentally, across the board, it's pretty slow. Commercial real estate for all the obvious reasons, the office retail, multifamilies is showing some -- a little bit of softening in some markets. And so I expect that, that's going to be a little slower. And -- I mean, frankly, the growth we've seen has been -- to some extent, has been -- draws on construction commitments, funding up, and we've seen a little bit of commercial growth but it's pretty anemic. So I think it's going to take -- it's going to take a little more clarity probably and probably if we see some rates come down a little bit without the economy tanking, I think that's going to be helpful.

Maybe thinking about deposits. So after you talked about the importance of liquidity after seeing [indiscernible] earlier in the year. You returned to customer growth, I think, over $3 billion in the prior quarter. How are you thinking about deposit growth going forward? Are there more opportunities to bring balances back that left onto the balance sheet? And you think we're now returning to sustained deposit growth for Zion?

Yes. I mean there's some -- I expect we'll see some additional -- see additional deposit growth this quarter and I think going forward, it's really going to be a function of loan demand. I mean we have a securities portfolio that's showing off about $3 billion a year. I mean we could I think we're going to be in a pretty comfortable place in terms of where deposits are. It's going to be driven ultimately by a resumption of loan demand before we have to go out and get particularly competitive again. I mean we're having to be competitive with larger accounts and everything is adjusted upward, but I think we're probably close to the end of that act in the play.

Maybe thinking about net interest income. You saw some encouraging signs improvement early in the third quarter. And then it appears that it retrends a little bit in September. I know 1 month doesn't make a trend. But when do you expect to see the bottoming in NIM and NII? And what gives you the confidence that we're getting closer to stabilization?

Well, One thing that's kind of -- I think it's kind of interesting. If you look at the deposit betas. We -- our total deposit beta in this cycle is about 37% to date, that could creep a little higher. I mean, I think even if the Fed stops, you're going to have a little bit of lag effect that tends to take place. If I look at the last cycle that looked quite a lot like this one was actually if you start mid-2004, through the end of 2006. During that period, you saw the Fed funds rate go from about 1%, to 5.25%, not really up to where we are today. Started a little higher, but -- but not much. Our deposit beta through that cycle was 41%. It's actually 4% higher than we are today, despite the fact that we had Silicon Valley in the middle of this thing. And so I actually think there's maybe a little more predictability in the entire deposit base. That than might appear on the surface. And we -- again, what we saw then, we saw a little bit of a lag effect. We saw another -- over the course of 2007 after the other Fed was plateaued at 5.25%. We saw about another 34 basis points at the deposit price cost, total deposit cost increase. So we could see some of that this time. But I -- in the meantime, you got assets repricing, we think that we're kind of getting to a point, especially with weaker loan demand, where we will have a little better control of deposit pricing and where we ought to be able to kind of find equilibrium. And where it goes from there, I really think it depends on resumption of earning asset growth before it really starts to climb.

And obviously, earning asset growth, it seems is going to be slower given the rundown securities and lack of loan demand. But the markets are sort of grappling with where interest rates are headed. I know you've studied inflation for many years. Just curious on your outlook for the economy in terms of where you think interest rates are headed? How -- what is the bank planning for in terms of interest rates in '24? And how does that impact the trajectory of NII, whether it's a higher for longer scenario or it's a -- or are we starting to see some rate cuts happening?

Well, predicting interest rates is probably a total fools errand, but I...

Loan growth.

Yes, like loan growth. Clearly, the market is expecting the Fed is going to -- we're going to see some cuts in the Fed funds rate in '24. And we're positioned, I think about as close to neutrally as we can be for that. All of our assumptions and our models, I mean, we've gone through -- done a lot of revising of models and assumptions in the wake of Silicon Valley. And so I'm less confident in any models right now than -- we're just in a different place than we've ever been before. But as best we can tell, we think that we're pretty neutral shape. I think ultimately, there's real risk that term rates rise. I just don't know how you reconcile some of the pressures that we're going to see on the federal -- the federal level debts and deficits, trillions dollars of interest cost coming on and probably over the next decade on average, according to CBO. It's -- I think it's going to be pressured environment for term rates. I don't know how they come back down short of a lot of Fed intervention, which I don't know -- I'm not sure they have the stomach for. I don't think it would be wise. So I think we may end up with something like a more normally shaped yield curve. We get a lower short end and some slope to it. And that wouldn't be all that bad in a lot of respects. I mean, we -- as much as I'd love to see term rates come down, stay down, let some healing take place, but I think that it's probably going to make more sense if we're going to see some sloped curve. And I tend to think that what we've seen in the last 2 or 3, 4 weeks has been a little bit of a head fake personally.

So big strength of the company has been the noninterest-bearing deposits. You've had a over 40%. They reached over 50% as search deposits entered. And even with the rapid pace of hikes, they're still at a very healthy level of 35% and -- but we've seen it moving around like you show signs of stability and then it's come back down. Can you maybe just talk about what your expectations are for your deposits? What are you seeing amongst your customers? Are they using it rather than borrowing? Are they investing in their business? And what have you done to reach the conclusions that you're getting to?

Well, first of all, we've -- it's obviously just natural. It would be expected that there is universal correlation between interest rates and demand deposit levels. So as rates have risen, what's happened is what we would expect to happen, that's what we've seen before. I do think that the 51% you alluded to included the impact of a lot of Fed policy that created a lot of money. And it was landing in bank accounts all over the place. And customers have been spending some of that down. I mean we're seeing that. That said, I think we're probably getting to a place where that level will probably stabilize if the Fed is finished. That the larger balances have already sorted things out and what's left is stickier and slower to move. So I -- my belief is we're probably pretty close to seeing that flatten out.

That's good to hear. Maybe just bringing together a couple of different things. You said maybe there's a little bit more upward bias on deposit costs. I think there was some confusion at earnings regarding the latent and emergent and what was being assumed in terms of the deposit cost rise. Can you maybe just clarify for us what is the actual company expectation for deposit costs over the intermediate time frame? And just as a follow-up, given everything that we've been through, you were forced to move to bring deposit costs up in a pretty meaningful way to support liquidity. How easy do you think it's going to be to bring deposit costs down when we get to the other side of this?

Yes. Well, first of all, the -- maybe some of the confusion was over -- we talked about, I think, 50% beta. I don't -- I actually don't think we get there. The 50% is actually alluding to kind of some assumptions that we're using in models, which are probably a little more conservative than I expect that we'll actually see. The actual behavior, again, I think it's going to be, if the Fed is done, I think we'll see total deposit costs continue to climb probably in the next 2 or 3 quarters, but at a decelerating rate. And then if the Fed starts to cut, I think you probably got about a lag of about a quarter and they start to come down. But I don't think there's any reason that I would expect that we wouldn't see betas on the way down that don't match what we saw on the way up without kind of the step function SBB impact, if you will. But if you look at the cumulative impact, I think there's likely to be -- back in 2007, '08, as the Fed was bringing rates down, we had about 37%, 38% deposit beta coming down. And I would expect we'll see that again.

So, you alluded earlier to the 3% headcount reduction in the fourth quarter, expenses have been increasing mid-to-high single digits the past years as you've increased customer acquisition, you were building out technology, investing in talent. Most banks are obviously trying to keep costs closer to flat in this environment. self-included or at least close to flat. But I think you recently highlighted inflation making that harder. Maybe just talk about how you're managing expenses in the current environment? And how do you think about the trade-off between making the necessary investments you need to in the business versus holding off for a better revenue environment?

Well, I mean the cuts we're trying to make, we're trying to be careful. I am truly a believer and it's -- I have -- I own a lot of shares. I've been in it for a long time. I think I've got a pretty long-term view of the world. And the one thing I've been trying really carefully not to do is to just act things that are the seed corn for growth a couple of years out. I mean, the technology investments we've been making are a good example of it. They've been -- that's something and you set it in motion and it becomes really hard to -- you don't want to be pulling back and then surging -- I mean we're trying to get through a big project. I expect, by the way, that I would hope that we're pretty much finished with that by late summer or so of next year. And -- so we've been trying to be kind of surgical. We've exited a couple of lines of business where returns it just become skinny. We've -- we gave everybody some targets in terms of headcount reduction, but it's not anything that is at this point, is going to actually get in the way of growing revenue, we're really focused on trying to find producers and people who can build the place. And I think you do that in times that are fat, at times that are thin and you're always trying to do that. But there are things where you cut back and you say, okay, we're going to postpone something that's kind of discretionary and I say it is not the right time to do it. That's a process that's always going on. You get a little more serious about it when you have something like SBB. But I think that's -- we're all going to be under those kinds of pressures. -- trying to keep things flat over the next year or two.

You talked about wanting to grow revenues. Obviously, over time, fee income has been a bright spot. It's been a little closer to flat recently. Talk about the fee income initiatives of the bank. Do you see this driving improved results in '24? And what are the main areas you're most excited about?

Yes, I certainly hope so. I mean what's happened with the 10 years, I hope helpful to what we're trying to do in our capital markets initiative, which we've been building out -- I mean, and it's not huge, but we have a customer base where we're going to be doing more to help with debt placements and syndications and swaps and a lot of things. And so we put together a really good team, headquartered out of Los Angeles. And that's over the last 2 or 3 years, been a bright spot. This last year was a little bit flat. But with a little bit of help from the markets, I do think that's one that over the next 5 years, going to see some good growth. Wealth management and other example where we've been building that business and it's been growing nicely. One of the things that is maybe weirdly helpful is -- I mean, we don't have a big consumer business. So I mean, the CFPB and this administration has been at war with the industry over fees. That's likely have less impact on us than others. So sometimes what you're not doing is -- can be helpful. It will have some impact, but not proportionately what you'll see from others, I think.

I know that your favorite part of every conference is to provide quarterly updates. So we'll take crack at it and just say, based on some of the comments that you've made, it sounds like maybe loan growth a little bit slower, deposit competition easing or maybe just any changes you've seen within the business over the last 60 days?

Not really. What we said after the end of the third quarter, I think that's still relevant today. I don't think this world hasn't really changed that much. So I mean, we tend to look out and say, what we -- we're not believers in saying, what's the next quarter hold and trying to -- we'd like to at least get people thinking about what's the next year look like? And it's going to be kind of a grinded out year. So nothing really new to add to what we've already said.

You talked about the big tech transformation, which is 10-year plus going coming to a conclusion in the late summer, I believe the deposit system is the last thing. I guess once this is done, what's next for the transformation? Is it cloud migration? More digital investment? What more is there to do?

Well, there's always a backlog. And I suspect you're going to see the whole industry spending money on what I think of as kind of internal AI is use cases where we can create productivity gains with internal modeling. That's when the OCC and Federal regulators are being pretty clear that they -- I mean, they're really wary of regenerative AI and sort of customer use cases. But there are a lot of opportunities internally to make people more productive in what they're doing to help with fraud and cybersecurity and a variety of things. And I expect that, that will be one of the places that we're investing. We just hired a new Chief Technology Officer that has some really good background in AI and machine learning et cetera. And it's one of the reasons we're looking to try to do more there. But there's a -- we're working on a project we call Sales force unification, trying to get to one instance of the use of sales force CRM tools within the company. And it's part of an ongoing quest to try and simplify the data environment and make it very consistent across the whole organization. So there are projects like that, that we'll be working on.

Maybe shifting to credit. Losses for you were still below 10 basis points amongst the best in the industry. Can you maybe just talk about areas of the portfolio you're watching maybe outside of office. We'll talk about that in a sec. Whether it's multifamily, other parts of C&I. And given your view of the world, what is a reasonable expectation for losses for Zion over a medium time frame?

Well, in terms of areas of portfolio we're focused on, multifamily is one. I don't expect -- I mean we've seen really good structure in deals, and we've seen it not just without -- we've seen it across the industry. I don't think it's going to be particularly problematic. I mean you're seeing some softening in some markets. So I think it's going to -- it will slow new originations more than anything. But that's one we'll be watching. We've been watching anything that's got much leverage in it. in a higher rate environment, that tends to be a kind of a target-rich environment for more trouble. And so far, not seeing anything that's giving us any concern. So I'm actually pretty sanguine about credit. We've been building our reserves just because we think it's a trickier environment than we've seen in some time and more question marks around it. But if we see a recession, it will create some losses, but I don't think -- I mean our goal has been, we said before -- is basically to be in the top quartile of the industry in terms of charge-offs. I think that's the ultimate measure of credit quality is all kinds of measures, and we all measure a lot of things. But at the end of the day, over -- through cycles, what charge-offs look like. And our goal is to be in kind of the top quartile, and we're trying to maintain a credit culture that delivers that.

So you referenced the allowances increased. I think it's gone up 6 straight quarters, even though we haven't seen much in terms of losses. Maybe just expand what is driving that? Is this mostly just qualitative reserves for rainy day? Or are you actually expecting losses to pick up?

Well, it's qualitative in the sense that we have -- yes, as we've as we thought about the -- we start using Moody's scenarios like a lot of banks do. And fundamentally, what we do. I mean they create several scenarios, and you can kind of a distribution around them. And they've got a base case. I mean, we've been waiting some of the more severe scenarios because we think that, that's actually more indicative of what we could see given concerns about -- on any concerns about government shutdown and recession consumers running out of cash, a variety of things. So yes, I expect that we'll see higher losses. I think we're pretty well reserved for it today. I don't think it's -- we're not going to just build it continually higher without evidence that the world is getting more difficult. But we are at 1.3%. That's not -- it's not -- it's high relative to 4 basis points, trailing 12 months' charge-offs, but relative to what we've seen going into a recession, we think it's about the right place to be.

Got it. Two more questions that I would hope to get through. Your capital ratios reported just above the peer median. TCE, obviously lower. Adjusted CET1 is below peers. How do those impact the way that you manage capital, even though you're not currently subject to the roles but at some point, are likely to be, how does that impact the way that you manage capital over an intermediate time frame?

Yes. Well, we think we've got about 4 years before we'll cross $100 billion organically. And that over that period of time, AOCI should pretty well bleed off. And the -- relatively a nonissue for us. With slower loan demand, I expect that we'll continue to build capital through '24. And my hope is that it puts us in a pretty good position to be able to start to return some capital even as we're preparing for crossing that threshold.

And just as a follow-up to that, maybe just thinking about the cost of doing that. And we talked about -- we took Comerica this morning about leapfrogging over the $100 billion, I think I've asked you that in 9 years when you finish the tech transformation, where does M&A fit in? And maybe I'll tie it into both that in regulation. Do you foresee M&A fitting into the Zion strategy down the road?

Well, I mean I absolutely wouldn't count it out. I think you get through this tech project. I think we'll have a really good platform. It's all about valuation. I don't think the regulatory, the $100 billion threshold is a reason to try to leap beyond that. The costs imposed by it, there's some onetime costs, stress testing, things like that, resolution planning. We fundamentally built a lot of that and have maintained it back in the CCAR days. The larger issue is Basel III end game and the debt requirement. And those are both -- those are both variable costs. So you're doubling size, is going to double the capital, is going to double the debt. And so I don't think those are economy of scale kinds of issues that would drive it. But there will be other things, just good fit, infill creating more efficient branch network in terms of larger branch sizes, things like that would be interesting to me, but not necessarily just trying to be larger for larger's sake.

Great. Well, I think we're in over time. So please join me in thanking Zion.