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

Okay. Good afternoon, everyone. I'm David Long. I'm one of the Raymond James bank analyst -- one of 5 Raymond James bank analysts. I'm the analyst that covers Zions Bancorp and welcome again to our 45th Annual Institutional Investors Conference. This afternoon, we're excited to have Zions Bancorp on site. Zions is an $87 billion asset bank headquartered in Salt Lake City with a market cap of about $6 billion. The bank operates in the Western part of the U.S. and in the Southeast region throughout Texas. Joining us for a discussion today is Scott McLean, President and Chief Operating Officer. He was named President in 2014 after spending 12 years with Zions Bank subsidiary in Texas Amegy, where he was CEO up until 2014. Earlier in his career, Scott was with Texas Commerce Bank and JPMorgan for over 20 years. Also with us from Zions is Shannon Drage, Head of FP&A and Investor Relations. She's held several positions since joining in 2010 within the accounting and finance, including CFO of subsidiary, Amegy as well. With that said, I'm going to turn it over to Scott for some opening comments before we get into an open discussion about what's going on at the bank.

Sure. David. Thank you. And thank you for inviting us to be with you today, and thanks for those in the room and those listening. I wanted to just provide a quick orientation and we're primarily going to work on Q&A with -- David with you, but just a quick orientation for those that may not know us as well. On Slide 3 here, you'll see, basically, our footprint is the Western United States. And what's distinctive about this -- the way we do business is you can see we operate under different brands. Zions in Utah and Idaho, California Bank & Trust in California, Nevada State Bank in Nevada, National Bank of Arizona. As I go through those names, they're awesome names. They are great names, and they connote local to our customers. And we're very much organized that way. We have really strong regional executive teams made up of CEOs and presidents that are known across their communities, which is very distinctive these days. It's hard to find someone that knows the entire organization of most of our global and regional bank competitors. So it is distinctive. I want to comment for a minute about for most companies, it's rare when you can say we're nationally distinctive in 1 or 2 things. Actually, we're nationally distinctive in quite a few. The first is that about 2/3 of our revenues come from banking, small to medium-sized businesses. pound-for-pound, we're one of the largest banks in the country for banking, small and medium-sized business, and that is nationally distinctive. Secondly, as you look at our information, one of the byproducts of that, and a very important one is that the relationship of our noninterest-bearing deposits to total deposits has been industry-leading among the top of the industry for about 3 decades now. That's not by accident. What causes that is the granular operating accounts that small- and medium-sized businesses keep with us. So because of our strategy to focus on small- and medium-sized businesses, we have this virtually industry-leading competitive advantage through many, many rate cycles, 30-plus years of noninterest-bearing to total deposits. Right now, it's about 37% at the end of the year. And most of our peers are in the high 20s to mid-20s, some even in the low 20s. That has been distinctive in almost any rate environment in the last 30 years. The next thing that is nationally distinctive is how these business customers feel about us. Greenwich Research, this references Greenwich, and actually we need to update it. Greenwich just announced their awards last week. Greenwich Research is the gold standard for evaluating how business customers feel about their banks nationally. They do over 27,000 surveys nationally of small- and medium-sized businesses. They give out national excellence awards. We finished third of those awards for 2023. We finished fifth the year before that, first in 2015. And if you look at -- since inception, when they started in 2009, there are only 2 other banks in the United States that have received more national excellence awards than us, neither of which compete in our markets. They both compete in the Eastern United States. So if you're going to have a scoreboard out there, it's important to win in that scoreboard and we have done it more so than virtually every other bank in the country in terms of how our business customers feel about us. I would also comment about credit quality. There's a lot of information about our credit quality over the last 15 years, and you've seen that our credit quality metrics have been outstanding and admittedly, a benign credit environment, but outstanding nonetheless and highly favorable relative to peers. The final thing I would mention is technology. Happy to go into Q&A in a little bit, but we've been on a 10-year journey to replace our legacy loan and deposit systems. So every bank you own, have ever owned, will own in the near future is using 30- to 40-year-old loan and deposit systems. Every single one of them. About 250 banks in the world have converted to modern cores. We've converted all of our -- virtually all of our loans now to our new modern core. We did it in '17 and '19, [indiscernible] our legacy 30-, 40-year-old systems. And we should complete the deposit conversion this year ending this kind of 10-year journey. At that point, we will be virtually the only bank in the United States that is fully on a modern core. Happy to talk about that in Q&A, but it's -- it will be, by definition, nationally distinctive and we think important in a digital world. Shannon, if you'll go to Slide 4, the next slide, most people saw in our first quarter results, good loan growth for the year, good loan growth for the quarter, good customer deposit growth as well. Credit quality was outstanding, again, as it had been. And we started to bend the expense curve down a bit more coming out of the inflationary period of '22 and early '23. And so those were really -- those were highlights as well as our net interest income stabilizing over the last 3 quarters. And I would say those are principally highlights. The stock price reacted really favorably. It was up about 15% in and around that announcement in the New York Community Bank hit about 10 days later, and the stock went down about 20%. So there's been volatility principally associated with other market activity that really has virtually nothing to do with us. That was pretty much the quarter, fourth quarter of last year. If you go to Slide 6, I think, Shannon, and I'll land the plane here pretty quickly. On Slide 6, what I'd really draw your attention to is ending deposits on the left-hand side and particularly the dark blue bars at the bottom, you can see that we started the year at $71 billion in customer deposits, and we ended the year at $71 billion in customer deposits. So like what's the big story here. Well, on March 10 of last year, Silicon Valley Bank failed. There was a lot of volatility in the deposit markets. You can see that our deposits fell but then grew at a very steady pace back up to $71 billion from $64 billion up to $71 billion. We used short-term borrowings, brokered CDs over the short term, and then we've been moving away replacing those with customer deposits. That's a great snapshot of what regional bank deposit volatility look like. So it was a fairly abrupt March and then really solid traction of customer deposits back to our balance sheet to exactly where we started the year. If you go to the -- just go to Slide 11, I think, Shannon. CRE is on everyone's mind. This is some -- 1 of about 5, 6 pages of disclosures we do on CRE. And basically, out of our $57 billion loan portfolio, we've got about $13 billion of real estate outstandings. 10.7 million of which is term loans. These are loans with -- to be called the term loan, you have to have stabilized cash flow basically. And then about 20% of the portfolio is construction. Everybody is really -- you can see on this slide also the average loan size is -- for the term portfolio is well under $4 million, median about $1 million or a little less. The office portfolio is about $2 billion, $2 billion out of our total balance loan portfolio of $57 billion. Average loan size, again, is about $4 million, median is $1 million. So don't think large urban downtown office buildings, you couldn't finance a downtown office building for that. These are smaller suburban, about 70% is suburban and smaller loan sizes, which imply more recourse, personal recourse on the part of borrowers. Happy to talk about CRE, happy to talk about office, but we think this is a portfolio that we will continue to provide a lot of disclosure on. And we feel as confident as you can feel going into a downturn that this portfolio will perform better. First of all, it's small and secondly, it performed better than most of those of our peers. With that, David, I'll throw the ball back to you.

Okay. Well, let's continue the discussion on credit. And we had dinner last night. So I kind of prepped you that I was going to ask this, but if you look back through the last 20 years and around the great financial crisis, the level of charge-offs for Zions were very elevated. My perception is that there's been changes made. And in the next cycle, my anticipation is that your charge-offs would run below your peers. Would you agree with that? And if so, what has changed? What have you guys done since the GFC to change how the bank underwrites across the franchise?

And actually, if you look at loans going back 15 years, our loss severity actually compares really well to our peers and the '08, '09 time frame, as you deconstruct that, the trends -- we had some negative issues, but it was all very manageable. And since that time, throughout the second decade of the century, we totally revamped our risk management practices, invested significantly in all elements of risk management. And when it came to credit, we became much more disciplined about our concentration management. So not just the concentration of CRE in our portfolio, but the concentration by product type and the concentration by geography. One of the easiest ways to see this is to look at our CRE growth, total commercial real estate growth during this period of time, over the last 10, 12 years. Our growth has been about 3% to 5% a year. The growth of our peers and most banks smaller than us has been 2 to 3x that rate over that same period of time. So we've been really disciplined in growing commercial real estate as well as observing these very important concentrations. I think the other important thing for investors to understand is that the underwriting of real estate loans changed dramatically post 2008. And just to give you an example, in most product types, office, multifamily, industrial, the amount of equity that we required doubled, literally virtually doubled. So an office building, pre OA would have had maybe 20% equity since 2008, most have anywhere from 40% to 50% equity, same doubling of equity in multifamily, industrial, retail, et cetera. Equity is a good thing. It's a really important thing. Secondly, we financed virtually no land. We had a lot of land, as you know, didn't start out as land. It was Phase 2, Phase 3 land of an office deal or a retail deal or an industrial deal, multifamily, the same. We don't finance any Phase 2 and Phase 3 land. Most of the industries have it, but we particularly have it. So we have virtually no land in our portfolio. Third thing is that when we used to negotiate covenants, if there was a default, it was really an invitation to a meeting. It was, hey, you're in default and then you'd start discussing what kind of additional equity or guarantees or collateral should be put up. In post-'08, real estate underwriting, most covenants are punctuated with a specific action. You will pledge additional capital, you will pledge additional collateral, et cetera, et cetera. So it's just -- and developers have handled those kind of defaults much more successfully than they did prior to 2018. Those would be just a few.

Okay. And just looking back to the fourth quarter alone, on the reserve level, overall, your reserves came down. Can you just talk about where -- why that -- why your ultimate reserves as a percentage of loans came down? And then what were the key drivers there that you guys -- Zions specifically looks at in managing that reserve?

Yes. And that would take about an hour to talk about, and it would take us into the deep dark murky world of what's called CECL accounting for loan loss reserves. The short answer is that most banks use some economic forecast. We use Moody's, a lot of banks use Moody's. And you saw us build our reserve for loan losses throughout the first 2 or 3 quarters of 2023 and the end of 2022 because we all thought there would be a national recession. And the Moody's forecast we're calling for a national recession in '23 and early '24. And so we built our reserve in those periods even though charge-offs were very low. Credit quality was -- metrics were very strong. That's just the way -- that's why the fundamental drivers of how the reserve is built in addition to grading every one of your loans. So there are multiple components. And what we saw in the fourth quarter was the external economic indicators were more favorable than they were early in the year. And we felt like our reserve was just fine where it was based on a more favorable economic outlook than we had as the year started. And we've had very little adverse grade migration loans that are going from pass grades to criticized or classified. That's the other thing that drives the reserve materially. And only in the fourth quarter, did we have a little bit of unfavorable grade migration.

Sure. Okay. You showed your map earlier, Texas, Utah, you're up in Washington, down to California, Arizona, a lot of geographies. Do you sense any difference in credit quality by geography or by state?

We really haven't seen that. We do at times. But right now, again, our credit metrics or criticized classified loans, nonperforming, charge-offs, those are the principal credit metrics. They're still pretty benign. So we haven't -- the losses we took in '23, which were small by any measurable standard, were idiosyncratic. They just were one-off events that happened in a $57 million loan portfolio. So I would say no specific geographic deterioration. Clearly, with office you have some markets that are doing better or worse. But generally, those vacancy rates are quoted for the center city and the ones that you read about, and there's clearly softness -- greater softness in some markets than there are in others.

Got it. Got it. Okay. And if you look over the last 6 weeks, there's been a bank in New York that's been in the headlines a little bit. They seem to have had a hiccup going over $100 billion in assets. If I screen $87 billion, you guys are pretty close. And maybe it's a couple of years away or a few years away, given your growth rate, what is Zions doing to prepare to be a $100 billion bank? And how close are you working with regulators today to ensure that if you do get there in a few years, you're where you need to be?

Yes. So first of all, you never want to see another bank go through a challenging time. They had some significant challenges in their announcement. And I won't go into it other than to say that I think we're in a pretty different position than there. You'd expect me to say that, but almost point by point, we could point -- we could indicate that. In terms of reaching $100 billion, you kind of -- you need to remember that we were a CCAR bank back when that started at [indiscernible] coming out of 2008 to great Recession. So we had to put in -- because we were regulated by the Federal Reserve and the OCC at that time and the FDIC. We're now just regulated by the OCC, which creates some differences. But we put in a lot of the stress testing, liquidity management, enhanced reporting then and even though we didn't have to comply with it in recent years, a lot of it we've maintained all that reporting and all that stress testing, et cetera, and actually enhanced it. So we don't think that when we hit $100 billion, they indicated they'd have $50 million, I think, of additional expense or some number like that. We don't think we're going to incur hardly any additional costs when we get to that point because we were sort of battle-tested coming out of '08, '09, and we have all that infrastructure for the most part in place. Where it will be different is if the new long-term debt requirement is if they keep that as part of the [indiscernible] game proposals, then that would have an impact on us, but it would be the same relative impact it would have on other banks or Zions. Shannon, anything you'd want to add to that or...?

Yes. I mean I would just say the other thing that we are watching and paying a lot of attention to is the proposed capital rule. There are a lot of indications that AOCI would be included as part of regulatory capital for banks that are $100 billion or more. So that's certainly something that we are managing to. The Board expects us to manage to whatever that final rule looks like. But we feel pretty good about the pathway to get there in terms of the phase-in period and what our AOCI accretion is going to look like for the next few years, we feel really comfortable that we'll be at a great kind of operating level with our capital.

Is it safe for me to assume, I know you guys have moved some securities from available for sale to held to maturity, that going forward, you would have a strategy that does keep some held to maturity at all times, assuming the Basel III goes through as proposed?

Yes. I mean it definitely changes how we manage sort of -- it limits our ability to manage interest rate risk the way we have. So we would be looking at how we do that going forward and certainly evaluating that.

Sure, sure. Okay. We talked -- you talked a little bit about this in the introduction, but we're coming up on a year on the liquidity. I'm not going to call it a crisis. Like I did earlier, let's call it, turmoil that hit the marketplace. You guys, at the end of the day, managed pretty well, but talk about what decisions you made internally about your deposits and your deposit flows that may have long-lasting impact on how you manage it.

That's a great question. Yes. First of all, we went into it with a really granular deposit base. All these small- and medium-sized businesses that make up our noninterest-bearing deposits which I mentioned, they're very stable, very steady. We saw volatility with large dollar deposits, which you would guess. And so a couple of things coming out. First, when we were at this time last year, we had about a little under $12 billion of customer deposits off our balance sheet that we swept -- they were coming through our accounts. They were our customers. The deposits came through their accounts with us and we swept them into off-balance sheet mutual funds. We really did that in 2020 when interest rates were 0, and the banking industry was awash with deposits. We basically said, "Hey, we can get you a higher yield off our balance sheet." And so our customers said, "Great." This is an ongoing discussion that you have with the client. But we had about $11.5 billion plus in those kinds of deposits. So what we did starting in June is -- kind of May and June is we went back to those same customers and said, we're now willing to pay a higher rate, will you bring it back on balance sheet and they did. And so that -- those off-balance sheet deposits are probably about $5 billion right now, plus or minus, and down from 11.5% almost 12%. So that was -- that's -- there were our customers before. They are our customers now, we just are paying them higher interest now than we wanted to in 2020. So that's been the source of the growth. And then in addition to new additional balances being brought into the bank. The other thing that's become really apparent, we thought we had a really granular deposit base, but it's caused us to look hard at how to continue to build that granularity. Consumer is one place we can do it easily because we're already double down on small businesses. So we have about 840,000 consumers that make up about 25% of our deposits, and those are all very granular for the most part. And you'll see us over the next couple of years talking about how to amplify that source of granular deposits because it's one of the biggest lessons coming out of large tenth event was the importance of granularity deposits and the importance of having borrowing capacity at the Federal Reserve and the Federal Home Loan Banks that is instantly callable. You can instantly access it. And fortunately, we had that instant access back in March, but we have it even more now. And I think that's an important liquidity management discipline.

Okay. As we look at deposit flows out to 2024, the Fed is still shrinking the balance sheet. It's -- there's some challenges out there to grow deposits. Do you expect the bank to grow deposits this year? And if so, what is the strategy to do that?

Yes. I think like it's been for us always, it will be organic. We've had one of the lowest cost of interest-bearing deposits for many, many years. That changed dramatically in -- during the spring and summer months. Basically, the deposit repricing we did normally would take place in any other cycle over 12 to 15 months. It took place in about 3 or 4 months. And so that was problematic. But you'll see our deposit growth be organic, and we will not -- we're not going to chase deposits with rate from where we are right now. And I think the greater opportunity is just simply to -- as rates come down or as we have the opportunity to reprice those deposits down from what we had to pay to bring them back on balance.

Got you.

But deposits will certainly grow over time. They do in the industry, they do for us. If you're a healthy banking company, notwithstanding pandemics and volatile Fridays like March 10, your deposits will generally grow about at the rate of the money supply or better if you do better than the industry.

Sure, sure. Okay. Let's talk about loan growth. It seems like a lot of small business, midsized business customers, your bread and butter customer. They're sitting on their hands right now. There's uncertainty. They may not be transacting. What do you -- what's your outlook for loan growth this year? And where will that come? Any growth?

Yes. We basically said we thought loans would be slightly increasing from this point from the fourth quarter.

Stable.

Stable, sorry. Thank you, Shannon. And so what we're seeing across our small and medium-sized businesses is just conservativeness. They've probably spent down some of the cash that they generated during the pandemic. And so there's a bit of cautiousness that is -- that we feel. And so we saw a slower loan growth in the fourth quarter than we had seen in previous quarters. We're actually coming off of about 5, 6 of the highest growth for us quarters in our history, coming out of the pandemic. And so you kind of look at it over time and I -- we don't worry too much about 1 or 2 kind of flat quarters or down quarters. It's really just insensitive to what your clients need. We've not changed our underwriting dramatically because of where we are with the exception of maybe office and multifamily where we started pulling back about 2 years ago. But the rest of our C&I underwriting, our 1-4 family underwriting HELOCs, we haven't materially changed over this period of time. And so I think the growth is going to come from C&I regular business lending, it's about 50% of what we do. And then you'll probably see some continued growth of 1-4 family as some of those construction loans fund out. And maybe a little bit in CRE just as the construction portfolio continues to fund, and it's not being replaced as fast as it was before.

Okay. And then just to close the loop on the lending side, any particular geography or subsidiary bank, do you see faster growth at one versus another? Or do you think it's pretty consistent across the footprint?

I think it's pretty consistent. Shannon, I don't know if you have a perspective on that, but it -- to me, it's pretty consistent. I'd be really slow to call out any one particular geography. I think Texas properly has a little bit better opportunity to grow, but they're all good markets. Good markets.

Yes. I mean we've been talking to our bankers and get pretty consistent messages about the pipelines being sluggish, customers just maybe cautiously optimistic at the end of the year, but not really ready to really start borrowing again at this point. It's in a much tenure. I think there's some trepidation amongst our customers for that. But I think Scott's right when we see sort of the borrowing demand return, it will come first in C&I.

Got it. Well, that takes up our 30 minutes. I'm not going to put us behind. Those of you in the room, if you'd like to join us, we're going to go down to Cordova 6 to continue the discussion. Scott, Shannon thank you very much for your time.

Thank you, David. Appreciate it.

Thank you, David.

Okay.