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

All right. Thanks, everyone, for joining us. Up next, we have Zion. I'll just read a quick disclosure. For important disclosures, please see the Morgan Stanley Research Disclosure website at morganstanley.com/researchdisclosures. The taking of photographs and use of recording devices is not allowed. If you have any questions, please reach out to your Morgan Stanley sales representative. And with that, we're delighted to have with us today, Scott McLean, President and Chief Operating Officer of Zion. Scott, it's great to have you here.

Manan. Great to be here. Thank you very much.

So Scott, I wanted to start with the overall environment, get a pulse check on what you're seeing. During the first quarter call, Harris highlighted that the level of uncertainty from tariffs was negative for sentiment across businesses. And then since then, we've had a few positive announcements. So how would that impact the customer sentiment?

Thank you, Manan. Customer sentiment, still, there's a lot of uncertainty. The genie is out of the bottle on tariffs, and I don't think anyone can put it back in, in terms of the mindset, the psyche of small- and medium-sized business owners. And about 65%, 70% of what we do of our revenue and our deposit balances are banking small- and medium-sized companies in the country. And so they -- whether tariffs are on or off, just the threat of it will cause them to take action. I think with small- and medium-sized business customers, they're immediately thinking back about COVID and the pandemic. And what they had to do there was to make sure that they had inventory. And in many cases, they couldn't [Audio Gap] you've got a gross profit margin of 20% to 40%. They learned they are never going to be without inventory again. And -- so I think what you're going to see is that small- and medium-sized businesses will move. They'll increase inventory, move their supply chains back to the U.S. more whether tariffs stay on or off. They're just -- the threat of it is enough to do that. And so I think that actually will probably be a good thing for loan growth ultimately. I think really big companies, it's a different story. I think, for them, it's more about capital investment, and it just is going to be really difficult for CEOs and Executives of large public companies to go in and commit to a 3-, 5-year capital investment and be able to talk with any certainty about long-term rates, inflation, the price of their products, all the kinds of things you would want to have some certainty about, if you were going to make an investment.

So it sounds like from these large capital investments, that's still on hold a little bit. For the smaller businesses, you are seeing some inventory build here?

Not yet. Not yet. I mean this story really just started in the first quarter. And so I think there's still kind of a wait and see that's going on. But when you think about where we were a year ago or 18 months ago, what did we think '25 would be like, I think we thought there'd be some kind of recession. I think we were really concerned about CRE. And so when you kind of go back and with that historical lens, basically, I think most people feel like we'll have lower GDP growth. But probably a positive operating environment, clearly, with a little more volatility. And I think the whole CRE topic, while there's risk in CRE loan portfolios, I think people are more comfortable with where that stands now and they can see the underwriting, the post-2008 CRE underwriting was dramatically different than pre-2008. Really holding these portfolios up pretty nicely. It certainly has for us.

And Zion operates separate entities in many different markets, and these are Carlifornia, Texas. Are you seeing any different trends in any of the markets?

We're really not. The customer survey work that we do is pretty consistent across, we're in 11 Western states starting in Texas and going to the west. And really, the only thing that we're seeing a little different right now is our loan growth in Texas has been stronger, it was stronger last year. It is stronger through the first quarter than it is in our other states. But really, operating conditions, I think, across our affiliates are pretty similar right now in terms of how customers are feeling and what they're doing. I would say though, for investors, we do operate in these different states and sometimes that's confusing to investors. We look decentralized. Our technology and back office have been consolidated since, the early 2000s. And then in the last 11 years, we had a lot of customization, even though we were highly centralized in operations and technology. But in the last 11 years, we've taken most of that customization out. So really, what is in these -- our separate affiliates is kind of the front end, the client-facing piece which is what you would want there the decision-making about client decisions, pricing and some middle office activities, but most of it is the real revenue-producing strength of our company.

And Scott, another comment that you made in April was that there was more than the usual level of uncertainty around the 1-year guidance that you gave. Has some of that uncertainty reduced given that we've clawed back a little bit, we pulled back a little bit from the peak and what could have been the peak in tariffs? Do you feel better about your guide today?

Yes. I think the funny thing about guidance, and it drives you guys crazy, may drive some investors crazy. Your guidance is kind of there to help complete your models, and I will understand what it's there for. But I don't think, you go back just 5 years, did anyone's guidance ever predict the pandemic? No. Did it predict Silicon Valley? No. Did it predict rates going up 500 basis points in '22? Silicon Valley in '23? Did it predict this tariff thing? The guidance -- it just doesn't embrace any of that really. And so that's why we work really hard to just make sure people understand the fundamentals of our business. And that is pound-for-pound being one of the biggest banks for small businesses in the country, having national recognition in that regard. Our deposit franchise has national recognition, our customer satisfaction scores are nationally distinctive. And we think our technology is now nationally distinctive as well. And so those are all things, I think, for long-term investors I hope speak more loudly than actual guidance.

Yes. So that's totally fair. And maybe we should dig into some of those more fundamental trends. On the loan growth side, you've spoken about focusing on the commercial side to drive loan growth from here. What are the biggest opportunities for the bank there?

Yes. So commercial lending makes up about 50% of our loan portfolio, about 20-plus percent is CRE and another 20%, 25% is consumer, principally 1- to 4-family mortgage. And the C&I side is very broad-based. Lot of just kind of fundamental general industry. And we're seeing moderate activity there. Again, I think, 3% loan growth doesn't really excite anybody. But the rest of the industry is kind of at that rate. And I think investors should look at that growth rate and go, you know what, again, going back 12 months, if you look forward, maybe a national recession. I think 3% loan growth is not a bad thing from a health standpoint. I think as we get through these tariff talks and maybe the economy become a little more certain, I think you're going to see loan growth pick up. We're also leaning heavily into our SBA lending activity and it's really exciting. We were the 20th largest SBA 7(a) originator -- and their fiscal year-end last October, we had originated 700 SBA loans. We're on track to originate 1,500 this year. It would take us from #20 to about #10. We just passed Bank of America, which is cool. They're a bank about 40x our size. JPMorgan and Wells, assuming we get to 1,500, I think we will pass them shortly. And so once we get to 1,500, that's a nice -- that will be nice 3 years of growth. Our goal is to go to 3,000 in the following 12 to 18 months, which would get us in the top 5. And you may -- it's not going to change our stripes really as a company. But when you think about it, it is really granular growth. It will have a positive influence on C&I. It is very deposit-rich type of lending. And there's a nice fee income component and a consumer banking component to it. So we finally just got kind of mad about it. We saw where our SBA rankings were and we thought, man, who other than us should be leading the league in SBA lending. And that's really what got us started. Harris Simmons, our CEO, just said, this is not, and off we go. And it's going to be a fun part of the story.

And to clarify, the 1,500, is that new client relationships or new loans?

It's a great question. And it's 7(a), we do 504 also. So it's just a component, but it's an important component. And some of it is certainly to existing customers. But it's about 50-50 right now, and that number is going to change over time. But quite frankly, if we never brought in a new customer, which is not going to be the case, related to this, about 70% of small businesses don't borrow from banks. They might have a business credit card or they're financing it personally. So 70% of your small business client base doesn't borrow. And so this is just a way to deepen our relationship with those and generally help them bring their banking needs kind of all to one bank.

And that gets you the relationship on the deposit side and the fees side and the lending side?

Yes. Absolutely. It should. I mean it doesn't just happen accidentally. But yes, if we do our job as bankers -- and most clients, when they get an SBA loan, it's kind of the difference between having a business or not having a business or really growing the business. I mean it's a life event. So generally, if we show up with financing, they're happy to do their business with us.

So you spoke about loan growth activity should pick up at some point as the confidence builds. You're making all these new investments. Talk a little bit more about the steps you're taking to benefit from that loan growth activity once it picks up. what investments are you making? What hires are you making?

Yes. It's not what we'll do when the loan growth picks up and I think is as important as what we need to do to make sure it picks up. And so we actually have made some real nice strategic hires in Salt Lake, some very exciting news there in Denver and in California. And so we're always doing that. But we are just highly focused on our fundamental call programs. And I just referred to it as shoe leather. We were in this 10 or 11-year period of modernization of our company with our big core transformation project, which was the first time it's ever been done in the United States. It's been done 300x around the world. But we're really the only bank in the country that has replaced its core loan and deposit platform. It's a really big deal. And -- so that is -- the benefit of that is that it's allowing our bankers to spend less time with our systems, they can spend more time out with our clients. But our call programs, we have a customer appreciation, calling campaign that we've been doing for a number of years. It's just a simple call. You just call a customer and say, hey, we appreciate your business. Any of our employees can do it. And it's stunning. We'll do about a 130,000 of these calls this year. It's stunning to see the anecdotal kind of positive things that comes from it. We also are very aggressively calling on the prospects. We've kind of got a top 25% of the prospects in any of our market. It's about 10,000 names that we're calling on across the company. A lot of banks just sit back and wait for referrals or business to come in. We've always been very forward leaning in this regard, and that's an important campaign. And I think the other element we're bringing forward is a new approach to marketing in our company. We've had really a solid approach to marketing, but I don't think it's been a strategic weapon for us, a strategic driver. And we'll talk more about this as the next 12 months unfolds. But we're going to be using much more active marketing that I think will be really helpful to our small business initiative and this SBA initiative to our consumer deposit growth initiatives and to all of our fee income products.

Got it. And maybe talk a little bit more about competition. You're clearly competing against not just other regional banks, but also the large money center banks in the small business arena. Talk about what you're seeing on the competition side right now? And how that's been evolving over the past year or so?

Yes. Manan, I've been in this business for 46 years. And it's just always -- I don't remember the time it wasn't competitive. And my main office is in Salt Lake, but I live in Texas. And folks have been parachuting into Texas for decades. And so we've seen a lot of banks come and go. And the playbook that they run is, increase everybody's compensation when they hire teams by 20% to 40%, maybe more. Big bonus packages, blah, blah, blah. They lower pricing to win relationships and big money spent on marketing and sponsorships. It's just kind of a worn out playbook and some banks have done it okay. But in what we do, small banking, small and medium-sized businesses, we -- there are always 4 to 6 proposals when we're trying to win a piece of business. So the fact that some big regional giant, regional banks or global bank wants to increase the branches in our market, blah, blah, blah. We just let them come on. Competition is a good thing. We are not worried about competing with anyone that wants to parachute into our markets. I think it's going to be a bad experience for them, generally speaking.

Especially in cases where you already have the client relationships?

Exactly.

Got it.

And we will -- when people run, hey, we're going to lower your price dramatically compared to what Zions affiliate is charging. We -- if it's a bank that has said they are going to dramatically increase their presence, we will fight like tigers. And if they get it, they are not going to make any money on it, and they are not going to be happy with it long term. So we're a pretty nice squad, but we know how to fight when we need to.

The other aspect of competition is not just from traditional banks, but also from private credit. Can you talk about how you're thinking about Zions relationship with private credit, both as a competitor and as a partner?

Yes. It's something we all ought to be really worried about. You guys have written about it. Everybody is writing about it. The growth in private credit, I'm not going to quote numbers, but it's been dramatic. And generally, those providers of private credit, they're outside the regulatory environment. They -- their terms are normally longer. Their covenants are weaker, their requirements for equity are less. And so when they're all in, it's a very -- it's going to be a volatile type financing. When we're in deals with them, we just have learned to become very careful about our position relative to theirs. And people think, just because you're senior, somehow you have a great position in difficult negotiations. It's not always true. It's just the more complexity in the capital structure, the more complicated it is for clients to work through difficult situations. I think what's going to happen with private credit is that it's going to keep growing until something happens on the regulatory environment. Something has to happen or it will just blow up like all things, they grow really fast and uncontrolled. It will blow up. And the problem with that is that a lot of customers are going to find out that they don't know who to talk to. They don't have anyone to talk to. And so it's going to be a reminder, and we've had different times like this in our past, it will be a reminder to customers that relationships really matter. They really do matter. And we'll be there to help pick up the pieces when that happens, but it will happen. It absolutely will, in this case.

And where is the traditional banking system winning business right now? So whether it's Zion, whether it's your peers relative to private credit, where is the advantage that the banks have?

No. It's a great question. I think the advantage we've always had has been on the relationship side. That's our advantage at Zions. And you'd have no way of knowing that other than looking at external surveying and it sounds like corporate speak, but if you look at Greenwich Research, which is the gold standard for measuring how business customers feel about their banks in the United States. They surveyed 500 banks, 25,000 surveys. Only 3 other banks in addition to us have received their scores of national distinction, national recognition as much as we have over the last 16 years. And 2 of the things that they measure is a bank that values relationships and a bank that you can trust. We have in our investor deck our scores on that relative to the global banks. The global banks are terrific. JPMorgan, BofA, Wells and U.S. Bank. They're just terrific banks, great people. But customers just think very differently about us. And so where we compete, I think, relationship matters, product matters, technology matters, price matters, et cetera. But relationship still matters. The fintechs there not really -- they don't really penetrate what we do. They penetrate consumers, they penetrate micro business, but they're not really a player in what we do. I think this -- you mentioned private credit, credit unions is another place that it's just inherently unfair. Credit unions, anybody can join any credit union on the planet. It's -- you don't have to have this general association anymore, practically speaking. And they have this tax advantage. And they're going into commercial lending, into real estate -- they're going into all the traditional bank businesses. And the reporting and the transparency on credit unions, again, wonderful people, I'm sure. But it's just totally different. And it's talk about an unfair playing field. And so when you talk about where do banks win? Credit Unions are -- they're alive and well, and they are tough competitors where they exist. And I just would submit like private credit, we really need some legislative and regulatory oversight of what is this industry and why is it continuing to be given a tax break?

Got it. Excellent. I want to pivot over to what you're seeing on the deposit side. Zion has seen 5 quarters of NIM expansion. A lot of that has been driven by success on the lowering deposit costs. Can you talk a little bit more about what's driving that?

On the deposit side?

Correct.

Yes. So one of the -- we start with a really strong deposit franchise. And our total cost of deposits is among the lowest of our peers, even after Silicon Valley, it's still among the lowest of our peers. And part of that is because our demand deposit, our noninterest-bearing deposit, the total deposit ratio has been peer-leading, industry-leading for decades. And so that strong noninterest-bearing balance franchise that we have is -- contributes to this overall lower cost of deposits. We haven't lost that. The mix, even though rates have changed dramatically, you can go back 30 years, and our mix in that ratio is as strong today as it's always been relative to peers. So I think that helps. The other thing that we saw, we basically said leading up to the rate cuts in the fall that our beta coming down would look a lot like our beta going up. And our beta going up was 40% overall, 60% on interest bearing. And so we're seeing that coming down, particularly of our highest priced deposits, it's about $15 billion in these larger highest price deposits. We had about 100% beta coming down from the 3 rate declines. That was not accidental. It actually took a lot of work to make sure that win rate is changed, we lowered our rates. And we did on that $15 billion that you can think of it, pretty much market rates are a little bit less. And so we are committed to as rate declines continue bringing that down instantly, but, we, among those highest priced deposits, we have a lot of opportunity to continue to kind of trim what we're actually paying without losing those deposits because they're all related, virtually all related to our existing commercial and private banking relationships.

So is there more room for the overall port folio cost to come down if rates don't go down further?

Yes. I think there is on deposit costs. Yes, I -- first of all, growth will help bring it down. Secondly, the fact that our demand deposits at the end of the first quarter had been declining like all banks in the entire industry. We're about $25 billion right now, and they were down a little bit in the first quarter, but it looked like they were stabilizing. And so to the extent we have that stabilization, then I think the overall cost of deposits will have further declines that they can go through. We also have some latency in our time deposits. So that's a smaller impact. But as that time deposit portfolio that we have, which is principally consumer, rolls over, we'll see some incremental benefit from that too.

Got it. And then as you think about NII, you've spoken about seeing NII growth even with rate cuts and flattish loan growth. Can you talk about some of the inherent tailwinds that you have on the asset side of the balance sheet that drive that?

Yes. Basically, you can see our NII disclosures, and we're basically assuming the forward curve at the end of March, it calls for about 4.5% NII growth. And it's coming largely from repositioning in our securities portfolio. We have about $750 million of cash flow coming off our securities portfolio each quarter. And about half of that we're repurchasing securities at higher rates. And the other half will probably pay down broker deposits or support loan growth. That's probably the biggest element that will impact that growth. And then we do have loan, some continued loan yield latency that is a positive in repricing. And that -- and then again, this DDA stabilization, those are probably the 3 biggest drivers of that growth.

And you spoke about the latent sensitivity of the balance sheet. How are you thinking about the overall asset sensitivity of the book as you think about the next few years, you are -- the balance sheet is more asset sense right now. Are you thinking about bringing that down neutral over time? Or how do you think about that?

That's a great question. We try -- ultimately, we try to keep the balance sheet pretty balanced. I mean, the sense of asset sensitivity. So we would try to probably have a little less asset sensitivity than we do today. But there is a trade-off if we have higher rates, long term rates, then we produce a little more AOCI and -- but we also -- for asset sensitive, we have more income to offset that. And on the downside, there's a little bit of risk there, but I don't think so. I don't think so right now. So we're -- we basically have this projection for asset sensitivity and I think it will play out, play out just fine.

Got it. All right. Perfect. Maybe talk a little bit more about the fee side of the business. Where are you prioritizing investments on that front, whether it's treasury management, card mortgage?

Right. So we've got about $635 million in fees that -- and it's a great collection of businesses. Treasury management is about 1/3, about 30% of our fee income comes from the operating services we provide to businesses. It's the workhorse of our fee income engine and it's nationally recognized. Again, Greenwich Research has given us national distinction in our treasury services. And so it's great when you're a workhorse, which is so critical to your primary client base is nationally recognized. And it's a business that should grow kind of mid-single digit, low single digit. We always grow a little faster than the industry is growing, almost always. And so that core workhorse is in great shape and is important to our growth. We then have a collection of other businesses like card, retail, business service charges, lending fees that have had some softness in the last couple of years. And they're actually showing kind of some low single-digit growth rates, some will probably migrate into mid-single-digit growth. And then we have some growth activities like our capital markets business, which we've invested a lot of money in, it's growing great. We were at about $70 million a couple of years ago in revenue. We were at $107 million last year. And it's just a great collection of capital markets activities. Interest rate hedging, foreign exchange, syndications, bond underwriting. We have a commercial real estate capital markets business that has a lot of upside from a revenue standpoint. And so that $107 million of revenue, what we basically said is that we think it's going to be a high growth, and it has been. And so it should continue to provide some nice positive energy. The other 2 thing -- wealth is that way, too. Our wealth business, the revenue has flattened a little bit, but it's a huge opportunity for us, and we've got great leadership there. So I think that will kick in. And the other places, our mortgage business, we've shifted from held for investment to held for sale. And when you do that, it just drives a lot more fee income. So I think where mortgage fees have not been a great driver of fees for us in the past, you'll see a real positive influence there. And I think the small business lending activity, even though the numbers aren't big, it actually could have a disproportional impact on overall fee income growth. So I'm actually pretty forward-leaning and positive about our fee income outlook.

All right. Perfect. Just talking about maybe credit. You noted that there's still some level of uncertainty for small businesses. Are there any specific sectors that you're looking at where you're seeing a higher level of stress? Anything to call out on the credit side?

We -- well, I think overall, our credit performance in terms of net charge-offs has been outstanding for 15-plus years. And more even before the Great Recession. So we run at about 10 basis points in net charge-off ratio. And most of our peers run at 20 to 40 basis points. And so it's a big strength. And a lot of it has to do with underwriting. Most of our underwriting is secured. And so as investors think about going into a recession, the first thing people think about is consumer unsecured, going into a recession. That's not us. We've got about $400 million of consumer unsecured. Not us. And if you look at our business portfolios, look at 2008, they performed great. They performed great in 2020. So if you look at our small and medium-sized business C&I portfolios have performed great in 2 real shock system -- shock moments. And our 1- to 4-family mortgage book also has performed well. CRE, lot of focus on that. We saw classifieds go up last year. And then we said in January, we thought they'd flatten out. And at the end of the first quarter, they were up a little bit classifieds, but not much. I think what investors should look at there, though, Manan, is that, while classifieds have gone up, nonperformers have stayed low. They've not gone -- that's really untraditional. Most previous cycles wouldn't show that.

And that's what drives the losses?

Exactly. And the losses we've had on commercial real estate have been negligible, by any measure, negligible even during this period of rising classifieds. So we actually -- there's a lot to play out with real estate, but I think we're well reserved. We understand the portfolio. And if there was -- given how long that cycle has been going, the deterioration in CRE, if it was going to produce losses, it would have started to produce it by now. I mean we're 2.5 years into that. And you would have seen nonperformers build, if the loss content was there.

All right. Perfect. We're almost out of time. I'll wrap up with a question on capital. There's a lot of volatility on the long end of the curve. How are you thinking about managing capital? And is there a CET1 ratio, including AOCI that you're managing through here?

Yes. For most investors and analysts, if you look -- CET1 has kind of been the most important measure that most people look at and understand. And now CET1 less minus AOCI. And so -- and on that, we screen lower than most of our peers. But that's why we are really transparent about how this AOCI mark that we have accretes back into capital. And so we -- you'll -- most analysts can look at it and go, okay, over a 4-year period here 3-, 4-year period, you'll see that AOCI accrete. We report on it every quarter. It hadn't changed hardly at all from our original projections. And capital improves and to where the original Basel end game kind of compliance date was June of 2028 and any investor, analyst projection would have us well above on CET1 minus AOCI, well above any requirements with buffers and more buffers, and we're in good shape.

And plus you have the earnings accretion as well?

Exactly. That's exactly right. So I think -- and I think most investors understand our capital ratio and I think our regulators do and the rating agencies do. So...

All right. Perfect. With that we're out of time. Scott, thank you so much for joining us.

Manan, thank you very much.