Zions Bancorporation N.A (ZION) — Q2 2023 Earnings Call Transcript

Thank you, Alicia, and good evening. We welcome you to this conference call to discuss our 2023 second quarter earnings. As many of you know, our long-term Director of Investor Relations, James Abbott, has decided to pursue a self-employment opportunity and we wish him well. My name is Shannon Drage, and I am the Interim Director until a permanent replacement for James is selected. 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 our press release or the slide deck on Slide 2 dealing with forward-looking information and the presentation of non-GAAP measures, which applies equally to statements made during this call. A copy of the earnings release, as well as the slide deck are available on zionsbancorporation.com. For our agenda today, Chairman and Chief Executive Officer, Harris Simmons, will provide opening remarks. Following Harris' comments, Paul Burdiss, our Chief Financial Officer, will review our financial results. Also with us today are Scott McLean, President and Chief Operating Officer, and Keith Maio, Chief Risk Officer. After our prepared remarks, we will hold a question-and-answer session. This call is scheduled for one hour. I will now turn the time over to Harris Simmons.

Thanks very much, Shannon, and we welcome all of you to our call this evening. We're pleased that the environment around the banking industry seems to have stabilized relative to the disruption we saw during the first quarter. One notable outcome across the industry has been the acceleration of deposit pricing. While deposit attrition appears to have been largely transitory, the higher cost of deposits remains. Beginning on Slide 3, we've shown some themes that are particularly applicable to Zions this quarter as well as those that are likely to be prominent over the near-term horizon. Customer deposits were up $2 billion for the quarter. We are grateful, but not surprised that our customers have demonstrated their loyalty and confidence in us. We continue to actively manage our balance sheet in response to changes in interest rate risk. This includes funding mix optimization, changes in our interest rate hedging strategies, and our product portfolio. We're also committed to managing our expenses in relation to a more challenging revenue environment. Our second quarter results reflect a $13 million severance expense related to our objective of flattening expenses over the next year. Our levels of non-performing and criticized assets declined slightly compared to the prior quarter. We experienced $13 million in net charge-offs higher than the first quarter, but well below historic norms and reflective of one-off events rather than portfolio trends. Loss absorbing capital increased and remains healthy, particularly relative to our risk profile. Turning to Slide 4, we've included a summary of quarterly financial results showing a linked quarter comparison with the first quarter of 2023. Circled on the slide, we reported total deposit costs of 127 basis points for the quarter compared with 47 basis points in the first quarter. Period-end customer deposits increased 3.2%. Including the impact of broker deposits, deposit growth was 7.4%. Loan growth has slowed year-to-date relative to 2022 to a moderate annualized pace of growth. Moving to Slide 5. Diluted earnings per share was $1.11. As shown on the right side, we accrued $0.07 per share or $13 million of severance expense. Offsetting that was an equal positive impact from the gain on the sale of a piece of property. These one-time items aside, the largest contributor to the decline in earnings per share was the impact of increased deposit and other funding costs on net interest income. We were successful throughout the quarter in maintaining and growing customer deposits through more competitive pricing, including moving customer deposits from off-balance sheet products to on-balance sheet products. These efforts are reflected in the higher cost of deposits. Paul will discuss this further in his comments. And turning to Slide 6, our second quarter adjusted pre-provision net revenue was $296 million. The linked quarter decline was attributable to the primary factors I've just noted and was slightly down compared to the year-ago quarter. With that high-level overview, I'm going to ask Paul Burdiss, our Chief Financial Officer, to provide additional detail related to our financial performance. Paul?

Thank you, Harris, and good evening, everyone. I'll begin with a discussion of the components of pre-provision net revenue, or PPNR. Over three-quarters of our revenue is from the balance sheet through net interest income. Slide 7 includes our overview of net interest income and the net interest margin. The chart on the left shows the recent five-quarter trend for both. Net interest income on the bars and the net interest margin in white boxes declined in the second quarter as our cost of funds, including the rates we pay on deposits, reflected the impact of the rising rate environment and more competitive pricing. Additional detail on changes in the net interest margin are outlined on Slide 8. On the left-hand side of this slide, we provided a linked quarter waterfall chart outlining the changes in key components of the net interest margin. The approximately 100 basis points adverse impact associated with deposits, including both changes in rate and volume, was partially offset by the positive impact of loans, lower borrowing levels, and the increased value of noninterest-bearing funds. As noted on prior calls, we have been more competitive with deposit pricing, a tactic that has accelerated in the second quarter due to increasing depositor sensitivity. Our success in growing customer deposits contributed to reducing the level of borrowed funds as we move through the second quarter, and noninterest-bearing sources of funds continue to serve as a significant contributor to balance sheet profitability. The right-hand chart on this slide shows the net interest margin comparison to the prior-year quarter. Higher rates were reflected in earning asset yields, which contributed an additional 187 basis points to the net interest margin. This combined with a nearly 100 basis point increase in the value of noninterest-bearing funds was almost entirely offset by increased deposit and borrowing costs. Our outlook for net interest income in the second quarter of 2024 is stable to slightly decreasing relative to the second quarter of 2023. Risks and opportunities associated with this outlook include realized loan growth, competition for deposits and the path of interest rates across the yield curve. Moving to noninterest income and revenue on Slide 9. Customer-related noninterest income was $162 million, an increase of 7% versus the prior quarter and 5% versus the prior year. As we have previously noted, we modified our non-sufficient funds and overdraft fee practices near the beginning of the third quarter of 2022, which has reduced our noninterest income by about $3 million per quarter over the past year. Improvement in commercial account fees, including treasury management fees, has allowed us to make up the loss of this revenue. Compared to the first quarter, customer fees grew $11 million, or 7%, due to strengthened loan syndications, interest rate derivative sales and other capital markets activity. Our outlook for customer-related noninterest income for the second quarter of 2024 is moderately increasing relative to the second quarter of 2023. The chart on the right side of this slide includes adjusted revenue, which is the revenue included in adjusted pre-provision net revenue and is used in our efficiency ratio calculation. Adjusted revenue grew 3% from a year ago and decreased by 7% versus the first quarter due to the factors noted previously. Adjusted noninterest expense, shown in the blue bars on Slide 10, decreased 3% from the prior quarter to $494 million. The first quarter typically includes seasonal items such as stock-based compensation for retirement-eligible employees and payroll taxes, and the second quarter, therefore, reflects a decrease due to the lack of those seasonal expenses. Reported expenses at $508 million include $13 million in severance expense associated with our intent to flatten expenses over the next year. Our outlook for adjusted noninterest expense is stable in the second quarter of 2024 when compared to the second quarter of 2023 and excludes any impact associated with the proposed FDIC special assessment. Slide 11 highlights trends in our average loans and deposits over the past year. On the left side, you can see that loan growth has moderated in the current quarter. Our expectation is that loans will increase slightly in the second quarter of 2024 when compared to the second quarter of 2023. Now turning to deposits on the right side of Slide 11, total deposits had declined for several quarters prior to the current quarter. And while average deposits for the second quarter were down slightly, ending balances grew 7% compared to the end of the first quarter. Customer deposits, excluding broker deposits, grew 3%. As noted previously, our deep customer relationships enabled deposit growth while also bringing new business to the bank. The cost of deposits, shown in the white boxes, increased during the quarter to 127 basis points from 47 basis points in the prior quarter. As measured against the fourth quarter of 2021, the repricing beta on total deposits based on average deposit rates in the second quarter was 25%, and the similar measure for interest-bearing deposits was 43%. On a spot basis, at the end of the second quarter, the total cost of deposits was 1.7% and the interest-bearing deposit yield was 2.8%, bringing the realized deposit betas to 34% for total deposits and 55% for interest-bearing deposits at the end of the second quarter. Earlier, I mentioned the contribution that noninterest-bearing funds have on the net interest margin. Slide 12 shows noninterest-bearing demand deposit volume trends. Although deposit volumes have been declining as more customers move into interest-bearing alternatives, the contribution to the net interest margin and therefore the value of the remaining deposits has increased significantly. Slide 13 provides additional information on deposits, including a stratification by FDIC insurance status. As the chart on the left shows, we reported a notable increase in uninsured deposits throughout 2020 and 2021 and has been previously reported, the level of uninsured deposits has been falling back toward historical levels. During the second quarter, the ratio of insured deposits to total deposits stayed consistent at 55%. The growth in insured deposit balances included both reciprocal deposits and broker deposits. Our loan-to-deposit ratio on the right side is at 77%. To put this in historical context, total deposits are up 30%, or 22% excluding broker deposits, since the end of 2019. Moving to Slide 14, our investment portfolio exists primarily to be a ready storehouse of funds to absorb client-driven balance sheet changes. On this slide, we show our securities and money market investment portfolios over the last five quarters. The size of the investment portfolio declined versus the previous quarter, but as a percent of earning assets, it remains larger than it was immediately preceding the pandemic. This portfolio continues to behave as expected. Principal and prepayment-related cash flows were over $900 million in the second quarter. With this somewhat predictable portfolio cash flow, we anticipate that money market and investment securities balances combined will continue to decline over the near term, which will in turn be a source of funds for the rest of the balance sheet. The duration of the investment portfolio is slightly shorter compared to the prior-year period, estimated at 3.7 years currently versus 4.4 years one year ago. This duration helps to manage the inherent interest rate mismatch between loans and deposits. With loan durations estimated to be 1.8 years and a larger deposit portfolio duration estimated to be about 2.5 years, fixed-term investments are required to bring balance to asset and liability duration. Slide 15 provides information about our interest rate sensitivity. A comparison of our model results to recent actual deposit behavior suggests reduced asset sensitivity, which we are showing on this page with the bars labeled as adjusted deposit assumptions. In light of this change, we are actively managing our asset duration to the emerging liability duration. During the second quarter, $2.5 billion of received-fixed interest rate swaps were canceled and $2.5 billion of pay-fixed interest rate swaps were added. On the right side of this slide, we've included detail on the impact current and implied rates are expected to have on net interest income. As a reminder, we have been using the terms latent interest rate sensitivity and emergent interest rate sensitivity to describe the effects on net interest income of rate changes that have occurred but have yet to be fully reflected in the repricing of financial instruments as well as those expected to occur as implied by the shape of the yield curve. Importantly, earning assets are assumed to remain unchanged in size or composition in these descriptions. These estimates also assume deposit behavior is in line with deposit behavior realized over the past 12 months. Regarding latent sensitivity, the in-place yield curve as of June 30 will work through our net interest income over time. Assuming a funding cost beta based on recent history, we would expect net interest income to decline approximately 4% in the second quarter of 2024 when compared to the second quarter of 2023. Regarding emergent sensitivity, if the June 30, 2023 forward curve — forward path of interest rates materializes, the emergent sensitivity measure indicates an improvement in net interest income of approximately 1% in addition to the latent sensitivity estimate in the second quarter of 2024 when compared to the second quarter of 2023. As noted previously, our outlook for net interest income for the second quarter of 2024 relative to the second quarter of 2023 is stable to slightly decreasing. Our loss-absorbing capital position is shown on Slide 16. Our capital position is aligned with the bank's risk profile. The CET1 ratio continued to grow in the second quarter to 10.0%. This when combined with the allowance for credit losses compares well to a very low level of ongoing loan net charge-offs. As the macroeconomic environment remains uncertain, we would not expect share repurchases in the third quarter. We expect to maintain strong levels of regulatory capital while managing to a below-average risk profile. On Slide 17, credit quality remains strong with non-performing assets and classified loan levels remaining stable and low. Net charge-offs were 9 basis points of loans for the quarter. Loan losses in the quarter were associated with borrowers that have struggled with idiosyncratic supply chain issues, delays in inventory build and changes in customer demand. We do not feel these are indicative of emerging stress in the loan portfolio, which otherwise reflected slightly improving credit measures during the quarter. The allowance for credit losses is 1.25% of loans, a 5 basis point increase over the prior quarter as a result of a somewhat weaker economic forecast. As we know this is a topic of interest, we have included detail around the commercial real estate portfolio, including the CRE office portfolio in the appendix of this presentation beginning on Page 29. CRE represents 23% of our total portfolio with office representing 17% of total CRE, or 4% of the total loan balances. Credit quality measures for this total CRE portfolio remained strong. The office portfolio credit metrics were stable with lower classified and criticized rates when compared to industry trends. There were no losses in the quarter across the CRE portfolio and we expect the CRE portfolio to continue to perform well based on the current economic outlook. Slide 18 summarizes the financial outlook provided over the course of this presentation. As a reminder, this outlook represents our best current estimate for the financial performance in the second quarter of 2024 as compared to the actual results reported for the second quarter of 2023. The quarters in between are subject to normal seasonality.

This concludes our prepared remarks. As we move to the question-and-answer section of the call, we request that you limit your questions to one primary and one follow-up question to enable other participants to ask questions. Alicia, please open the line for questions.

Hi, good afternoon. Thanks for taking my questions. I wanted to start on some of the trends that you saw on deposit balances and deposit rates during the quarter. At our conference last month, you had mentioned that your NIM was approaching about 2.85% on average for the quarter. And I know it came in a little bit better at 2.92%. So, I was wondering, is that a function of the rate of change improving in June? And it sort of sounded like that based on some of the spot rates that you mentioned, but I was hoping you could give some more color there.

Yes, this is Paul. I would like to refer you to the appendix of our presentation. I am currently looking for the page number. In the appendix on Page 22, we show trends in net interest income, the net interest margin, and noninterest-bearing demand deposits. What you can observe there is a flattening of those trends, which is influencing our outlook.

Got it. And then, maybe on the expense side, you had some severance costs this quarter. If you could expand on what the ongoing benefit is from those cuts? And to the extent that some of the pressure on deposit costs and cost of funding returns, how much more room is there for further expense cuts either through ongoing expense saves or cuts in non-core businesses?

Sure. This is Paul. I'll start with that response. I am reluctant to quantify the specific expense associated with the severance, because it's part of a much larger program. And the larger program is meant to create a noninterest expense level a year from now, which is roughly consistent with the current quarter, excluding the FDIC special assessment. So, as it relates to whether or not there's further room to the extent the environment changes, that's the kind of thing I think that we're going to have to manage through to the extent those possible changes might occur.

Great. Thank you.

Thank you.

Good afternoon.

John, good afternoon.

Just on the noninterest-bearing deposit mix, I know it's around, I guess, just shy of 40% right now on the end-of-period balances as of second quarter after the 7% decline in balances this quarter. Where do you see that bottoming out in terms of that noninterest-bearing mix? I know it's already below the pre-pandemic levels. Thanks.

The challenge with the ratio involves two numbers. We're seeing positive growth in interest-bearing deposits, which makes it difficult to identify a specific base for that ratio. It reflects the total deposits, but the broader economic environment significantly influences it. If interest rates rise again, we may experience more pressure on that ratio. However, our outlook for net interest income over the next year includes expectations for a shift from noninterest-bearing to interest-bearing deposits. This is factored into the beta figures I've mentioned. It's important to monitor total deposit costs and their impact on net interest income over time. We have lost over $10 billion in demand deposits in the past year, but my expectation is that we won’t lose as much in the coming year under our baseline assumptions.

Absent a lot of further increase in rates.

Yes.

Hey, John, this is Scott. The slide that Paul highlighted, Slide 22, illustrates the continuing decline in demand deposits during a time of rising interest rates, but it's important to note that these deposits have increased in value. While noninterest-bearing deposits are lower, they are worth more now than they were a year ago, which has a positive impact. Additionally, regarding our DDA mix and total deposits, we have maintained a competitive advantage in the ratio of noninterest-bearing deposits to total deposits for over two decades. This is also shown in the slide deck and the appendix, specifically Slide 25. We do not expect this long-standing relationship to change significantly compared to our peers in different interest rate environments, as it reflects our banking strategy and the nature of the deposits we attract, which are small operational accounts that are less affected by interest rate changes.

Great. Thanks, Scott. Appreciate that. Then secondly, just on capital return. I know you indicated no real intention to buy back the stock in the third quarter. Just give us an update, what could change that? What could bring it back in the market for your shares here? Thanks.

I'll start there. There's a lot of uncertainty I think including in the regulatory environment around where capital rules are going. And just given the environment and the uncertainty around that, we think it's prudent to continue to build capital organically. As I noted, our goal is to balance the risk profile with the capital position of the organization. And to the extent the macroeconomic environment becomes clearer, the capital sort of regulatory rules become more clearer, then it's possible that you could see us be a little more active. But as it stands, my sort of near-term expectation is that there's so much uncertainty that my personal expectation is that we wouldn't be very active in that market.

Great. Thanks for taking my questions.

Okay. Thanks, John.

Hi, everybody. I wanted to start, so looking at, one, the growth of broker deposits, and then two, how customer deposits have started returning to the balance sheet, what's the opportunity to replace some of those broker deposits with lower cost customer funds here?

Steve, thank you for that question. This is Scott. The events in March, starting on about March 9 or 10, that was a really quick change in jolt to the marketplace. And I think what we tried to demonstrate through March and into the second quarter was the ability to utilize broker deposits, which we did over the short-term period, March, April, that time period. But then, we were also pulling on the lever of our higher priced commercial suite products and reciprocal deposits. Really all three are important levers for any bank, and I think investors should draw comfort when a bank can demonstrate it can utilize all three. We're seeing, as you noted and as Paul noted, good progress in building customer deposits, both sweep deposits, particularly, and CDs. And I think what you'll see is that we'll continue to have success with that. And our brokered CDs will go down, absent some other big shock to the system, I think pretty confident that's what you'll see over the next six months.

Yes. The other thing I'll note is those brokered CDs are in a sort of a laddered format. So they've got kind of an average maturity of about six months. So there's an opportunity, as Scott said, to replace them as we're able to grow customer deposits.

An important point to note is the growth in interest-bearing deposits for us. We didn't just start discussing liquidity and the interest rates we offer to our customers. If you look back to 2021, during the zero interest rate environment, we were encouraging clients to move their deposits off our balance sheet. We began the quarter with approximately $12 billion in off-balance sheet customer deposits and advised them to make that move because money market funds were offering higher returns than the banking industry. So when we began actively engaging with our clients in February and March, and into the second quarter, about our on-balance sheet rates, it was not the first time we addressed their liquidity. Generally, our customers were pleased to bring their deposits back on-balance sheet, and we anticipate that this trend will continue as we become more competitive with our pricing on short-term deposits.

So, if I could follow-up on that, interest-bearing deposit costs increased materially this quarter, right, 130 bps, the brokered were a key part of that. And if we think about the ability maybe to start replacing some of those, and I'm staring at your loan yields, that's only 5.65%, so some repricing opportunity there, how far away are we from your NIM troughing?

Sorry, I just want to clarify the question.

From a troughing.

Thank you. Troughing, that was the term I overlooked. When we think about our outlook, which indicates net interest income might be flat or slightly declining, and consider that alongside what I would characterize as modest loan growth, along with an investment portfolio that will continue to see paydowns—I want to highlight that we had nearly $1 billion in paydowns this quarter—my expectation is that earning assets will generally be flat or decreasing. Therefore, if we combine those factors, looking at revenue as the numerator and earning assets as the denominator, I believe we're nearing, barring any unforeseen circumstances, the lower boundary of the net interest margin in the current environment. In fact, the spot net interest margin at the end of the quarter was very close to the average for the quarter.

Okay.

The cost of interest-bearing deposits was 2.22% during the quarter. If we exclude the broker deposits, it was 1.62%. To your point, the additional customer money we are bringing back is costing more at the margin than the average. However, there is still some room to reduce that a bit.

Okay. Thanks for taking my questions.

Thanks, Steven.

Hi, this is actually Nick Moutafakis on for Chris. Just going back to the interest-bearing deposit costs, could you guys remind us of your total IBD beta assumptions?

I think you're asking about the assumptions that we use in our interest rate risk modeling. Is that correct?

Correct. Yes.

If I could direct you to the slide deck, we have a section specifically addressing interest rate risk and the modeled outcome. There are two sets of bars presented. The second set reflects what we refer to as adjusted assumptions, as we've noticed that deposit betas have surpassed expectations from our models for various reasons. This information can be found on Page 15 of the slide deck. As you consider the future, it's crucial to focus on the betas we've experienced since early 2022. Our net interest income outlook takes into account the latest view on beta, which is very similar to the beta we've observed since the beginning of 2022.

If I examine the standard compared to the adjusted on Slide 15, it appears that the only factor is the increased beta, along with a dynamic shift from noninterest to interest-bearing, or it could simply be a higher beta.

Yes, when I refer to beta, it includes the rate of change in interest-bearing deposits as well as a shift from noninterest-bearing deposits to interest-bearing deposits. Therefore, it represents a combination of mix shift and repricing speed.

Okay. And then, maybe just paydowns coming off the securities book just quarterly. If you could help me out with that? I don't know if it's in the slide deck or not here.

I mentioned in the script that the net paydowns were just over $900 million in the current quarter, with a range of between $750 million and $1 billion expected over several quarters.

Great. Thanks.

Okay. Thank you.

Thank you, Alicia, and thank you to all for joining us today. If you have additional questions, please contact us at the email or phone number listed on our website. We look forward to connecting with you throughout the coming months. Thank you for your interest in Zions Bancorporation. This concludes our call.