Zions Bancorporation N.A (ZION) — Q3 2015 Earnings Call Transcript

Thank you, Sabrina, and good evening everyone. We welcome you to this conference call to discuss our third quarter 2015 earnings. Our primary participants today will be Harris Simmons, Chairman and Chief Executive Officer; Scott McLean, President and Chief Operating Officer; and Paul Burdiss, Chief Financial Officer. I would like to remind you that during this call we will be making forward-looking statements, although actual results may differ materially. We encourage you to review the disclaimer in the press release dealing with forward-looking information which applies equally to statements made in this call. A fully copy of the earnings release, as well as a supplemental slide deck, are available at ZionsBancorporation.com. We will be referring to the slides during this call. We intend to limit the length of this call to one hour, which will include a question-and-answer session. During that sessions we ask you to limit your questions to one primary and one related follow-up question to enable other participants to ask questions. With that, I will now turn the time over to Harris Simmons.

Thanks very much, James, and welcome to all of you as we discuss our third quarter results. On Slide 3 of the text presentation are some key points, and several of these are highlights or initiatives that are working well and within expectations. There are a couple of areas that still need some improvement, and I'll touch on a few of these in my remarks. But as an overarching comment, I would say that I'm very encouraged with both the pace of the improvements and the very substantial nature of the projects on which we are working, all of which are designed to help produce return on equity that is considerably stronger than our recent results, as well as to maintain strong asset quality and to enable the Company to be more nimble at adapting to a rapidly changing banking environment, which in turn we expect will drive solid and sound growth. So the first thing I'd mention on Slide 3 is the charter consolidation efforts are working well. As I mentioned in the press release, we've received regulatory approval to consolidate our seven subsidiary banks under a single national bank charter, and we expect to complete that on December 31st this year. And in addition to regulatory approval, many of the tasks that need to be accomplished are tracking well, and I'm pleased with the work of a lot of groups within the Company that are working hard to make this happen on schedule. We will continue to emphasize our locally oriented leadership structure and the power of our strong local brands in each market we serve. We really believe that's the strength of the Company. We're simultaneously streamlining our risk and credit organizations and enhancing the local credit decision-making authority that we have out in the field. On Slide 4, we're introducing a new scorecard graph with the bar on the left illustrating the commitment to achieve $120 million of gross cost savings by 2017. The bar on the right illustrating the projected progress to be achieved by year-end. We are on track to achieve half of the targeted cost reductions by year-end. And I would note that our subsidiary banks are already exceeding 50% of their total aggregate goal. We are encouraged with the achievement of non-interest expenses at or below the $400 million level. For the quarter, our commitment is to hold that line item adjusted for certain restructuring costs to below $1.6 billion for the year. We are spending considerable time preparing the Company to continue to realize the remainder of the gross cost savings and to keep non-interest expense below $1.6 billion in 2016 as well. I would direct you to Slide 5. Another key measure of our commitment to shareholders is to reduce the efficiency ratio to 70% or below for the second half of 2015. And we're encouraged with the achievement of an efficiency ratio of just under 70% in the third quarter. We are reiterating our commitment to achieve an efficiency ratio of 66% or better in 2016, as well as those other targets that we first communicated on June 1st of this year. On Slide 6, we highlight the progress that we've made and expect to make with regard to our systems upgrade. I'd invite you to read this in its entirety, but the high-level summary is that we are broadly tracking in line with our schedule, we are making significant investments to provide a very strong technology foundation for our future investments that will simplify our operating environment and give us the ability to be highly competitive in an industry where digital capabilities and technologies generally are going to play an increasingly important role. There is simply a very substantial amount of work that is taking place to keep all of this on schedule and on budget. On Slide 7 we display some information with respect to our loans and deposits. The loan growth rate is below our targeted objective. We're working to improve in that area. Some of that is due to the attrition of energy loans, which have historically been a meaningful contributor to growth. However, during the past year, that portfolio has obviously declined substantially due to the decline in commodity prices and the resulting decline in borrowing basis and general activity in that sector. I mentioned earlier that our risk management practices are curbing our appetite for the incremental higher-risk deal, and we expect that the benefit of this decision will manifest itself with tempered credit quality metrics and credit costs during any period of future stress, and ultimately in the form of a lower cost of capital as a result. Deposit growth, shown in the chart on the right, has been a strong story for Zions for many years, and the source of that growth has come primarily from the most valuable source, non-interest bearing deposits. Although the ratio of non-interest bearing deposits to total deposits may certainly be expected to decline somewhat in a rising rate environment, the intrinsic value of those deposits should increase at an even faster rate and thus provide a lift in the economic value of equity and a very substantial increase in earnings, as that happens. With that brief overview, I'm going to turn the call over to Paul to review the financial results.

Thank you, Harris, and good evening everyone. I'll begin on Slide 8. For the third quarter of 2015, Zions reported earnings of $84 million or $0.71 per share. Although there was some noise that was detailed in the press release, which I'll point out in the call, the noise largely cancels out and we believe that the third quarter reflects a good platform for growth. Relative to the prior quarter, after adjusting for the one-time loss related to the sale of collateralized debt obligation securities, earnings per share were unchanged from $0.41 per share. Relative to the second quarter, net interest income was largely stable. Fee income, after adjusting for items such as securities and asset sale gains, was also generally stable. Non-interest expense declined to less than $400 million and the year-to-date result is tracking to below the $1.6 billion target even before adjusting for items such as severance. Looking at the provision for loan and lease losses, we had expected a moderate build in the reserve for energy loans, partially offset by continued reserve release in the rest of the portfolio. The elevated provision of the third quarter was affected by elevated net charge-offs. Although we do not expect the forward one-year net charge-offs for energy loans to remain at the elevated third quarter level throughout the period, we do expect some further charge-offs as the energy industry's financial condition continues to develop, and those charge-offs are likely to be somewhat lumpy due to the larger average size of those loans. Details of our investment portfolio are shown on Slide 9. We have been adding securities to our investment portfolio for the last year or so, reflecting the need for a permanent high-quality liquid asset position in light of the new liquidity coverage ratio rules, and more broadly, in order to manage balance sheet liquidity more effectively. Our efforts to build out the investment portfolio are expected to add revenue in the current and downside economic environments. Well, when we began this program, we indicated that we were targeting a portfolio of mortgage-backed securities of about $6 billion to be accumulated over a period of two to three years. During the third quarter we accelerated the purchases somewhat as we added a net $670 million on average to our available-for-sale investment portfolio when compared to the second quarter. In light of a general market expectation for rising short-term interest rates, we are exercising caution in how much potential revenue due to asset sensitivity we forgo as we purchase fixed-rate investments and how much duration extension risk we take in the investment portfolio. The securities we are adding are relatively short in duration, just over three years. The duration of the entire securities portfolio is about 2.6 years to date, and if rates were to rise by 200 basis points across the curve, our model indicates that the duration of the entire portfolio would only modestly increase to 2.7 years. Importantly, the addition of these fixed-rate investments did not adversely impact the asset sensitivity of the Company, as shown in the table at the bottom-right of that slide. Turning to loan growth on Slide 10. Net commercial and industrial loan growth is about 4%, excluding the effect of energy loan attrition which we have accomplished without an adverse change in underwriting standards. Meanwhile, construction land development loans have increased about 17%. Most of this growth is attributable to increased line utilization on commitments. We manage loan concentrations based upon commitment levels relative to capital, both base and adverse, and as a result, we have limited commitment growth on CMD loans. We are continually reviewing concentration levels as well as portfolio statistics such as loan-to-value levels and we feel comfortable with the quality of the growth we have experienced. Residential mortgage continues to be a focus, although production in this category is significantly impacted by the shape of the yield curve. The two portfolios that have been in decline for the past year or more are the national real estate portfolio and the energy portfolio. The national real estate portfolio represents about 6% of loans, and the attrition here resulted in a drag of just over 1 percentage point in the overall growth of loan portfolio during the last year. We are currently expecting that the national real estate portfolio attrition would remain fairly high, although perhaps somewhat slower over the next year than in the past year. The energy portfolio attrition is well-documented as we have discussed this very regularly during the past year, and our outlook remains consistent. We expect continued attrition as our clients actively work through the current environment for energy prices. We expect the rate of decline to taper slightly, although possible factors such as resurgence of capital market activity in the space result in a fair amount of variability in the range of our outlook. To summarize, our outlook and loan growth for the next 12 months is for a slightly to moderately increasing portfolio, which would be in the low to mid single digit rate of growth range. On Slide 12, this provides more detail on loan yields. Specifically, the coupon on new loan production versus the total portfolio, which we believe is helpful in understanding the risks due to yield on loans in the current interest rate environment. The yellow line reflects the GAAP loan yield on the portfolio. The primary reason for its decline is the previously mentioned impact related to loans purchased from the FDIC. Importantly, the weighted average coupon of loan portfolio has been stable over the past couple of quarters. The coupon of course excludes the effective amortizing fees, discounts and premiums. The yield on new production declined 9 basis points from the prior quarter, essentially due to a shift mix in production to somewhat larger loans in the third quarter when compared to the second; although not shown in this chart, the coupons in the various loan types and size cohorts were relatively stable with the exception of larger loans which remain under pressure. Although our loan officers are seeing some pricing pressure in the smaller loans space, our production coupons have been stable. Touching briefly on non-interest income and non-interest expense, our focus on fee income growth is generating good traction. I'm confident that the increased reporting and accountability that we have added to better track success in problem areas within fee income will result to materially stronger fee income growth than we have experienced in the past. And Harris has already discussed our non-interest expense and efficiency efforts, so I won't repeat them here. I will provide our expectations for non-interest income and non-interest expense when we come to our 12-month outlook summary. One more item of note on the income statement. The effective tax rate for the quarter was about 7 percentage points lower than our typical effective tax rate. This is due primarily to investment tax credits realized this quarter related to alternative energy and research and development. And all the effective tax rate was positively impacted by nearly $1 million of these one-time items in the third quarter. We expect our effective tax rate to be closer to a more traditional 35% going forward. Slide 11 breaks down key components of our net interest margin. The top line is loan yield, which declined 4 basis points from the second quarter to average 4.18%. Although there were various positives and negatives, the one that stands out as the primary driver of the overall loan yield decline was the decline in interest income related to loans purchased from the FDIC in 2009. That portfolio has substantially outperformed relative to our expectations at that time. However, in the third quarter, the income was more in line with our modeled expectations, which resulted in a decline of income from those loans from approximately $12 million to $7 million. This adversely impacted loan yields by about 5 basis points and reduced the net interest margin by about 3 basis points when compared to the second quarter. Our base case scenario for this pool of loans is that annualized earnings that we experienced in the third quarter, that level, will taper slightly as we move forward. The securities portfolio yield declined this quarter due largely to the changing composition of portfolio as we add new bonds within our guidelines for duration and extension risk. Shown at the bottom of the chart is our cost of funds as a percent of earning assets, which continues to be quite competitive. In addition to loan portfolio yield dynamics, the net interest margin was also adversely impacted by the shift in the mix of the balance sheet toward greater concentration of cash and securities, which carry a lower yield than the loan portfolio. Turning to credit quality, on Slide 13, I'll be brief and say that we continued to experience generally strong credit quality performance in most geographies and segments. Within the C&I segment is most of the energy which we have discussed has experienced some stress, and Scott will discuss that next. Our reserves for credit loss is quite strong at 1.6 times our non-performing assets and nearly five years of debt charge-offs based on the third quarter annualized results. Despite the increase in classified energy loans of just over $110 million from the June 30 level, overall classified loans increased only $30 million in the third quarter. With that, I'll turn the call over to Scott to discuss energy lending in the Houston market more broadly.

Thank you, Paul. If you look at Slide 14, you'll find the table we included in our earnings release, and I'd like to make a few summary comments. First, you'll notice that energy loan outstandings and commitments have declined, while classified loans have increased by about $118 million since June 30th, which aligns with our earlier forecasts for the year. Secondly, we've mentioned that we have several methodologies for projecting potential charge-offs, and these approaches suggest estimated energy losses ranging from $75 million to $125 million for this cycle. This is a manageable figure considering the overall size of our company. Although it's not shown on this slide, we previously indicated in this release a commitment to building our energy loan loss reserve above 4%, which we consider a strong reserve by any standard. The charge-offs we experienced in the third quarter were primarily linked to companies that have had difficulties since the last downturn and are not reflective of our current underwriting practices. Slide 15 provides an overview of the economic environment in Houston. The key takeaway is that Houston has been among the top job growth markets in the United States for several years. Job growth in 2015 is expected to remain flat, with a possible increase of 10,000 to 20,000 jobs. Historically, Houston has generated between 80,000 and 110,000 jobs annually over the past four to five years, but this trend is expected to slow to flat for 2015. While business owners’ sentiments are cautious, as shown in the PMI chart, other indicators like housing, new car sales, and hotel performance continue to be strong, likely due to substantial capital investments exceeding $20 billion in the petrochemical refining and LNG export sectors along the Texas Gulf Coast. Moving to Slide 16, we see a slight increase in vacancy rates in office spaces, as well as in the multi-family and retail sectors, which constitute the majority of our other exposures. Although vacancy rates are steady, multi-family vacancies are expected to rise over time, putting pressure on rental rates. However, our multi-family projects in lease-up during 2015—about two-thirds of our portfolio in Houston—are achieving rental rates higher than our initial underwriting estimates. Now, let's turn to Slide 17, which provides an updated perspective on our exposure to commercial real estate in Texas. The left side of each bar indicates our exposure in Houston, which has increased slightly from the previous quarter due to new originations, transitioning from construction to term commercial real estate as buildings meet our service level criteria, as well as draws on existing construction commitments. We maintain a conservative loan-to-value ratio and debt service coverage on our construction and term commercial real estate portfolios in Houston, which we believe will be a strength during this downturn. However, we are closely monitoring this situation, as we have in previous discussions. While I'm open to discussing our exposure to specific product types, there are key points regarding our commercial real estate exposure in Texas that are important to highlight. Compared to the 2008 downturn, we are in a more conservative position today. For instance, commercial real estate balances are currently about $1.2 billion less than in 2008, and our land exposure is approximately $150 million, down from roughly $950 million during the last cycle. This land exposure is well-established and has seen minimal underwriting since the prior downturn. Additionally, we have reduced our construction lending exposure and shifted our focus toward increasing term commercial real estate originations. Generally, the equity needed for office and multi-family construction financing today is significantly higher than in the previous cycle. I'd be glad to discuss these aspects further. Paul, I will turn the call back to you.

Thank you, Scott. I'll conclude our prepared remarks on Slide 18. This reflects our outlook for the next 12 months relative to the most recent quarter. On loan balances, we are maintaining our slightly to moderately increasing outlook for loans, due primarily to the factors already discussed today. On net interest income, we are maintaining our outlook for net interest income at moderately increasing, it does not include the effect of any rate increases by the Federal Reserve, although we expect to benefit a benefit to annual net interest income of about $125 million for each 100 basis-point move in short-term rates. We expect that non-interest income, excluding dividends and securities, gains and losses will increase moderately as we continue to focus heavily on this area. One note as we consolidate the charters, dividends from federal agencies, namely the Federal Home Loan Banks, will decline, and of course there's a relatively new risk that dividends on our Federal Reserve bank stock would also decline depending upon congressional action. But even with those headwinds, we are generally comfortable with the level of consensus. As stated previously, we are committed to holding non-interest expenses to less than $1.6 billion for both 2015 and 2016, excluding severance and restructuring expenses. We remain comfortable with our flat to slightly positive outlook on the provision, assuming energy prices remain relatively stable. As announced after the close of the market today, we expect to deploy up to $180 million of cash to tender for a portion of our preferred perpetual preferred stock and depository shares outstanding. This includes the tender premiums and accrued dividends, thus the paramount retired is expected to be less than $180 million. Ultimately we expect this action to reduce preferred dividend by about $10 million going forward.

Thanks, Paul. And Sabrina, at this point in time, would you open the line for questions. Thank you.

Hello everybody.

Hi.

Just maybe one on energy and a follow-up. Scott, could you just share with us what the criticized balance was of energy loans in the quarter?

Yes. Criticized outstandings for the total energy portfolio were about 23%.

Twenty-three percent.

I would just add.

It was about 20% last quarter.

Yeah, it was about 20% last quarter, so, about $60 million or $70 million linked-quarter increase.

Okay. Scott, just to follow up on your comments, I found them interesting, the $75 million to $125 million of losses through the cycle. Could you give us a sense of the probability of default and loss given default assumptions or at least maybe ranges? Because your numbers are a little bit lower than what we're thinking. What's underlying that?

Well, basically there's four methodologies that we've used, fundamentally. And one was our CCAR estimates, which basically had oil at about $50. And then we had a second methodology which was a credit-by-credit analysis, so it was a very bottoms-up review based on the specifics of each credit and their current grade and all the aspects of each one. So it was very much a bottoms-up analysis. And then the two final types of analyses we've done. The first was taking the worst loss year we had, which was approximately 1% for a 12-month period, and applied it over a nine-quarter period. So we took our worst annual loss and assumed we had that same loss rate for nine quarters. So we're assuming kind of a U type experience here as opposed to the V which we experienced in 2008-2009. Nine quarter also tracks, obviously, nicely to the CCAR methodology. And then the final version was we took our worst classified experience ever and we applied an aggressive loan loss rate to that. The four of those really triangulate around $75 million to $125 million.

Okay. Perfect. Thanks for taking my questions.

Thanks. I wanted to highlight the comparison between the period-end securities and the average. The average increased by approximately $650 million, whereas the period-end available for sale rose by $1.4 billion. This indicates there may be a significant increase heading into the fourth quarter that we can benefit from.

Yeah, Marty, this is Paul. Thank you for your question. You characterized the numbers correctly; we were growing the portfolio over the course of the quarter. The ending balance ended up being about twice the average. I would expect that ending balance to carry into the fourth quarter, with continued growth from here.

The mortgage-backed premium amortization, you highlight that, you didn't really put an impact around net interest margin. How much of that impact the quarter's margin?

The amortization itself wasn't a significant factor, Marty. It was about the overall growth.

I think it's about 2 or 4 basis points.

Yeah. I think it's about 3 basis points, Marty.

Okay. And with the income from the FDIC loans, James, was that also offset in the expenses? So, was it kind of a move from net interest income to favorable expenses?

It's a good question. The impact on the non-interest expense was fairly insignificant. We experienced a reduction of about half a million to one million in non-interest expense due to decreased income from FDIC-supported loans. The total amount shared with the FDIC for the quarter was $1.5 million, which is not a substantial figure in terms of non-interest expense.

Okay. And lastly, the $75 million to $125 million, just realm kind of park, how much of that has already been provided for, you know, just in percentages? What do you think you kind of got your hands already in the reserve? And thank you for the time today.

The reserve I mentioned was over 4% and energy outstandings are approximately $2.8 billion. So the reserve is at the higher end of that range.

Thanks.

Yeah. Hey, good afternoon. Just around your original CCAR expectations of about $300 million of preferred redemption, you're doing $180 million now. Would you expect to do some more in the first half of 2016?

We've got until June of 2016 to complete that $300 million. Currently, we're at a total cash value of $180 million, and I anticipate the remainder will be completed in the first half of 2016.

Okay. Regarding the $10 million reduction, is that reflected here in the fourth quarter, or will that be the full run rate in the first quarter of 2016?

Yeah, I wouldn't expect to see that full run rate until the first quarter of 2016.

Okay. And then just on your provision guidance, for flat to slightly positive, so that's not off of this $18 million this quarter, is it? That's still off zero, right?

It's off of zero, that's a good clarification. Thank you.

Okay, got it. Okay, thank you.

Thank you.

Hello. Thank you for taking the question. On the 66%, sub-66% efficiency ratio target for 2016 and the low 60's for 2017, clearly you're sticking with that. But is there any shift in the makeup between revenues and expenses given that loan growth seems to be coming in a bit lighter than expected but maybe do more on the revenue side, on the expense side, to offset that?

Yeah, I would tell you that we, you know, I think we still expect to see a little better loan growth as we go into 2016. But the fact of the matter is we're starting with a smaller portfolio than we thought we would have coming in to 2016. So I expect that we're going to have to be working very hard on the cost side.

And then just following up, fees you're now talking about a slight to moderate growth rather than moderate growth previously. So what's changed in the thinking there?

I think we are facing some challenges, as I mentioned earlier. The charter consolidation will result in reduced dividends from the Federal Home Loan Banks, and there’s also the potential issue of Federal Reserve Bank dividends to consider. Therefore, we are adjusting our outlook based on these factors.

And Paul, would you like to provide some details on the Federal Home Loan Bank dividends and the large number of Federal Home Loan Bank memberships we have?

Certainly we can discuss that if there’s interest. We have several banks under the Federal Home Loan Bank rules, where a bank is part of the district it resides in. With the charter consolidation, we will have one bank, CBNA, based in Salt Lake City. Consequently, our relationships and shareholdings with the Federal Home Loan Bank will be consolidated into the Federal Home Loan Bank of Des Moines. As a result, due to the way the Federal Home Loan Bank system operates, there are minimum share ownerships for each bank, which will drop to zero among these other banks. This leaves us with fewer shares of Federal Home Loan Bank stock, leading to lower dividends.

Great. Thank you very much.

Thank you. First question. Scott, if I heard you correctly, you mentioned the deterioration in energy credits. It seems these are poor credits from the last downturn and not ones you would have underwritten recently. My question is, what portion of your current $2.8 billion portfolio pertains to the last cycle, specifically the borrowers that may be at higher risk compared to your current underwriting standards?

Ken, thank you. You heard me correctly; the charge-offs have primarily been from borrowers who were struggling in the last cycle and have been barely managing since then. For whatever reason, we haven't been able to completely move on from them, and this recent downturn has been yet another severe setback for them. However, I would say that most of the underwriting reflects some adverse selection. When considering the transactions we charged off, there are just certain cases that are unavoidable, no matter how hard you try. That said, the majority of the portfolio is primarily based on the underwriting we've conducted over the past four to five years.

Got it. Okay. And then the other question, just for Harris. When you think about loan growth, obviously it has come in a little bit weaker. I know you guys want to improve that, but how much flexibility or how much I guess different initiatives or incremental incentives can you offer to actually better loan growth? Or is it that you are just subject to the environment that you're in?

It's clearly a combination of factors. We are taking tangible steps to manage risk carefully. I have concerns that we might experience another downturn before the economy strengthens significantly. Therefore, we are being cautious. For instance, we have hired additional mortgage loan officers to increase our presence in the market. We are also focusing on improving our internal processes for turning around loans, especially for smaller business loans and consumer credit, to enhance our pull-through rate. These actions aim to foster growth without compromising quality. However, the environment remains challenging. We are also maintaining discipline around pricing, which is an integral part of our company culture. While we may need to give up some competitive ground, it is essential for managing our portfolio growth. Balancing these aspects is our current priority.

Understood. Okay. Thank you very much.

Yeah.

Hello, this is Michael Young in for Jennifer. Just had a question again on loan growth. You know, energy bank was about half of the loan growth sequentially this quarter. Can you just talk about your outlook, if that's, depending on energy and Texas being a little bit weaker and growing slower there ex the energy component, or do you expect a lift in some of the other areas to pick that up?

I would expect some improvement in other areas. Regarding Texas, outside of Houston, the situation remains relatively strong. I believe Texas still has potential for non-energy related growth. However, this will depend on the performance of the energy sector there. In other regions, we are operating in some robust economies. We're observing growth in Colorado, Utah, California, and other markets we are involved in. Therefore, I remain optimistic about the potential for loan growth.

On a linked-quarter basis, I want to clarify part of the question. Out of the $89 million in loan growth for the quarter, the energy sector actually saw a decrease of approximately $42 million. The areas of growth for the quarter included Zions Bank with about $52 million and California with around $117 million. These were the two standout areas of strength.

One other aspect to mention regarding loan growth is that we have seen activity in energy as well as from our national real estate portfolio, particularly in low loan-to-value small business credits and commercial mortgages. We are assessing ways to manage the pace of payoffs. There's a noticeable amount of refinancing occurring in the commercial real estate portfolio, as many are attempting to secure long-term fixed-rate financing. Therefore, we will focus on exploring potential strategies to slow this process down, as it could positively impact our loan growth.

Thanks for that. Could you provide a breakdown of the classified loan percentages by type?

Sure. This is Scott. The upstream classifieds are about 22%. Midstream about 5%. Energy services about 18%. Total energy 15 - 16%, sorry.

Okay, great. That's all for me.

Thank you.

Thanks. Good afternoon. Paul, first question, regarding the $6.6 billion securities portfolio compared to your original $6 billion goal, how much more do you plan to build on that? And the increase in premium amortization you mentioned, is that solely due to the portfolio growth and not a one-time occurrence?

A significant portion of the amortization increase is tied to the growth of the portfolio. However, we have observed some accelerated prepayments in certain areas, such as Ginnie Mae ARMs that were originated before 2015, due to changes in the government fee program in January. Overall, you're correct that most of the increase is mainly related to the expansion of the portfolio size. We will continue to monitor this in relation to our cash position. As you may have noticed, while we've been growing the portfolio, our overnight money market position hasn't changed significantly, largely because we are experiencing strong growth in demand deposits, which is a positive development. We will keep expanding the AFS portfolio as it is appropriate to do so.

Okay. My second question is regarding the pickup in the size of the portfolio. We will continue to monitor that in relation to our cash position. As you have observed, we have been growing the portfolio, but our overnight money market position has not changed significantly due to strong growth in demand deposits, which is a positive development. Therefore, we will continue to pursue growth in the AFS portfolio as it makes sense.

Sorry, I would remind you that that $6 billion includes a lot more than just mortgage-backed securities, right?

Absolutely. You mentioned the debt reductions that occurred in mid-September and one that is expected mid-quarter. I just want to understand the $8.6 million interest expense you discussed on Slide 18. Will that be eliminated? Additionally, could you clarify what the long-term debt run rate will be compared to the approximately $18 million to $19 million you paid this quarter?

Yeah. The $8.6 million we quote there is the expense we incurred in the third quarter related to the two pieces of debt that are going away. One went away in September 15th and the other goes away November 16th. So, mid-September and mid-November. And as you know, these had rates on them approaching kind of combined 15%, 16%, and just under $250 million. So that's kind of how that math all comes together.

So, will the $8.6 million be completely gone in the first quarter?

Yes.

Okay, got it. Just wanted to make sure on that. Thanks a lot.

Yup.

Hey, good evening.

Good evening.

You have covered most topics, but I wanted to ask about the credit. It seems that you had a small amount of recoveries this quarter, possibly less than in previous quarters. Do you think you've reached the end of elevated recoveries going forward? I'm also curious about any offsets you might have against potential additional credit costs related to energy.

I would say there are still occasional recoveries from the crisis era, but they will become less frequent. I am aware of a couple that we might see in the next six months that are significant. However, overall, the situation will be inconsistent and generally on a downward trend.

Great. Thank you.

Good afternoon.

Hey, John.

Regarding credit, the projected losses range from 75 to 125. At the upper end, this suggests a cumulative loss through the cycle ratio of approximately 4.5%, which is only slightly higher than the 3% cumulative loss experienced in 2008. Is that 3% figure accurate? Additionally, it seems to me that this current estimate would likely be significantly higher than what we observed during the 2008 cycle.

Our losses from inception to date, which spans from 1997 to the beginning of this year, total $60 million in net charge-offs over approximately 17 years. Depending on the measurement period, this equates to around 3%. However, this loss rate is notably higher than our past experiences. We did consider historical loss data, but we also implemented a duration of 9-1/4 in our loss methodologies. To summarize, the projected losses of $75 million to $125 million indicate a higher loss rate than we have historically faced.

Okay. And on the capital front, I would like to hear your thoughts on how the actions you're taking with the balance sheet are affecting your position for CCAR. You're allocating cash, reducing CDOs, and paying down debt. Additionally, there are changes with Basel III under the 2016 CCAR. How does this all position you for the 2016 CCAR from your perspective? Have there been any updates to your estimate of the impact of these factors considering recent economic changes, the interest rate environment, and oil?

Our overall outlook hasn't changed. We'll evaluate the economic situation when the CCAR instructions are released. We've been taking numerous steps to prepare for the CCAR environment. The main concern we have is energy, as its future commodity prices are uncertain, particularly regarding how the Federal Reserve will handle these in their economic assumptions for the CCAR scenario. It's tough to predict an outcome with CCAR. However, we're actively working to ensure we can manage our own path regarding CCAR.

Okay. Thank you.

John, I’d like to add a bit and ask Scott to discuss some of the differences between the loans we currently have in the energy portfolio and those we had during the 2008/09 period, particularly regarding the presence of second liens.

Sure. We had some second lien financing before the 2008/09 downturn, but we have none now. During the 2007/08 period, there was a trend where reserve-based borrowers accessed the capital markets for significant amounts of junior debt, including senior unsecured subordinated debt in tranches ranging from $200 million to $1 billion. Total leverage was much higher then. We began to move away from that shortly before the downturn in 2008, but similar practices were prevalent throughout the industry during that time. In this cycle, we have been diligent in avoiding such trends. I can tell you that this tendency began to emerge again in the market throughout 2014, and somewhat in the second half of 2013. Therefore, it's beneficial that we managed to steer clear of those types of transactions in this cycle.

Yeah. I think we've mentioned it before, but I'll reiterate that we essentially exited several loans during the 2014 timeframe that had much higher risks. We started moving away from that just before the downturn in 2008, but we had more exposure to it like the rest of the industry during that downturn. In this cycle, we've remained diligent and disciplined to avoid that trend. I will say that we started seeing that tendency returning to the market throughout 2014, and a bit in the second half of 2013. Therefore, I believe it's positive that we managed to steer clear of such transactions in this cycle.

That had that characteristic. I would also note that we are continuing to maintain our fundamental underwriting on oilfield service, which proved effective up to the last cycle. We have remained committed to that discipline, and the private equity firms we collaborate with, which number around six to seven on the reserve base side and six to seven on the oilfield service side, are the same ones we've been working with for many years, in some cases for 10 to 15 years. This consistent group also navigated the last cycle with us. This is a positive aspect because they backed their credits during the previous cycle, and we are already seeing them support their credit this time as well, although it's important to remember that each cycle is different. Nonetheless, we have strong relationships with these individuals.

Got it. Very helpful. Thank you.

Great. Scott, I was just curious if you could give us a little color on how the redetermination process is going so far relative to your expectations, and did that affect your reserving much at all this quarter?

Thank you for the question, Joe. I wish I could provide a definitive answer, but the process has just begun. The deck we will use this time is around $45 for the short periods, and as you know, we follow the curve out. This time, the curve is a bit flatter compared to the $50 deck we used in the spring, which is a significant difference. We expect to fully capture all of this by late November or early December. In the spring redetermination, we observed a decline in our borrowing base of about 10 to 11%. There's been a lot of discussion about this, some of which accurately reflects the industry's expectations for this round. I believe we will see borrowing-based declines in a similar range, probably exceeding 10%, with a potential decline between 10 to 20%. My guess is it will be in the mid-teens. However, this is still forthcoming. To address your question, the current redetermination did not influence our additional provisioning in the third quarter. That said, we reviewed our spring redetermination where the sensitivity was set at $37.50, which we measured all our borrowing bases against and examined carefully when prices were around $40. This informed our additional provisioning in this quarter. Now that prices have rebounded a bit, we are looking at sensitivities below $37.50 for this redetermination.

That's helpful. Paul, could you clarify the FHLB dividends? Specifically, could you provide details on the potential fees we might lose and when we could expect to see that reflected in the income statement?

The timing will likely be in the first quarter. I'll discuss the dollar value with James.

Okay. Sabrina, I need to interrupt you for a moment. We have six questions remaining and only five minutes left. Let's do a lightning round, one question per person, and we’ll try to keep it brief from here on.

Good afternoon. Can you share your insights on the lessons learned from the review of the oilfield services portfolio this quarter? Specifically, how did it affect the debt to EBITDA ratios or coverage? What did you learn, and do you anticipate any additional challenges for that portfolio in the upcoming quarters?

Sure. And you're saying lessons learned this quarter? Because that's what's impacted, you know, that was the bigger issue this quarter, correct? Well, yes. But we said since last December that you would see oilfield service classifieds build in principally the third and the fourth quarter. We said you would see a little bit in the second quarter. This was all the way back to last December, we saw very little oilfield service move in the second quarter. We said back then it would happen in the third and fourth quarter, and so it is. And that's principally just based on the fact of when you receive financial statements, and there was a positive hangover from the end of last year in terms of activity that was going on for oilfield service companies. So I would say no real lessons learned in this quarter, it's exactly the way we thought it would play out. I would say though that I'd be really careful, as banks quote debt to EBITDA numbers, you know, EBITDA numbers are going to be going down, those debt to EBITDA numbers are going to become really almost a useless statistic, because they'll be eye-popping. They wouldn't be anything you'd underwrite at. It was just going to be because of the vanishing EBITDA, so.

A few of the charge-offs were associated with companies that had been struggling for a long time. And they were very close to the drillbit on the energy services side.

All right. Thanks. I'll move along.