Zions Bancorporation N.A (ZION) — Q3 2023 Earnings Call Transcript

Thank you, Alicia, and good evening. We welcome you to this conference call to discuss our 2023 third quarter earnings. My name is Shannon Drage, Interim Director of Investor Relations. 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 or Slide 2 of the presentation 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 presentation are available at 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; Keith Maio, Chief Risk Officer; and Derek Steward, Chief Credit 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 want to welcome all of you to our call this evening. Zions Bancorporation recently celebrated the 150th anniversary of its, what we think of as an ancestral bank, which was Zion's Savings Bank & Trust Company, which opened for business in October of 1873. I would like to think that this is a bank that's been built the right way, steadily and prudently over many decades, with a persistent focus on developing deep roots in the communities we serve and helping customers develop their own strong financial foundations. As one of the West's most prominent pioneer institutions, we look forward to a great future, building on this history and demonstrating a continued commitment to the values that have served us so well over these many years. One other thing that I want to comment on before we get into the numbers. During this past quarter, Michael Morris, who has very capably served as our Chief Credit Officer for the past decade, retired from the role due to some recent health challenges that led Michael and his family to conclude that he should reduce his workload somewhat. I'm very pleased that Michael will continue with us in a role focused on affordable housing and related projects where I know he'll add a great deal of value. Michael's close and very capable associate over the past decade, Derek Steward, has assumed the Chief Credit Officer role and as Shannon noted, he's with us on the call today, and we welcome Derek into this really important position in the company. So going into the slides, financial performance for the quarter was marked by sustained stabilization of our net interest margin as well as significant customer deposit growth, both of which have been very encouraging. Customer deposits grew $3 billion during the quarter and resulted in reduced reliance on both short-term borrowings and brokered deposits. We continue to actively manage our balance sheet and our hedging in response to changes in our interest rate risk profile. We've had a pretty dynamic and proactive response to changing conditions and this has contributed to the stabilization of the net interest margin and net interest income. We recognized $14 million in net charge offs during the quarter, which is in line with the prior quarter, while loss-absorbing capital increased with common equity Tier 1 capital up 7% compared to the prior year. Capital levels remain healthy, particularly relative to our risk profile. Turning to Slide 4, we've included some key financial performance highlights for the quarter. We reported total deposit costs of 192 basis points for the quarter compared with 127 basis points in the second quarter. Period end customer deposits increased 5%, while brokered deposits declined 22%, bringing total deposit growth to 1% quarter-over-quarter. Period end loans were flat to the prior quarter as we observed softening loan demand in the third quarter. Diluted earnings per share was up $0.02 over the second quarter to $1.13 on net income of $168 million as lower expenses offset slightly lower revenue. Our third quarter adjusted pre-provision net revenue was $272 million, down from $296 million. The linked quarter decline was attributable to lower non-interest revenue while adjusted non-interest expenses were flat. Versus the year-ago quarter, PPNR was down 23% as the increase in the cost of funds exceeded the increase in earning asset yields.

Thank you, Harris, and good evening, everyone. I'll begin with a discussion of the components of pre-provision net revenue. 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 shows the recent five-quarter trend for both net interest income on the bars and the net interest margin in the white boxes, which were consistent with the prior quarter as the repricing of earning assets nearly kept pace with rising funding costs. Additional detail on changes in the net interest margin is outlined on Slide 8. Our success in continuing to grow customer deposits contributed to the reduced level of brokered deposits and borrowed funds as we moved through the third quarter, and non-interest bearing sources of funds continued to serve as a significant contributor to balance sheet profitability. Our outlook for net interest income in the third quarter of 2024 is stable relative to the third 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 non-interest income and revenue on Slide 9, customer-related non-interest income was $157 million, a decrease of 3% versus the prior quarter due to strong capital market fees in the second quarter. Customer fees were in line with the prior year as the year-over-year decrease in capital markets was offset by approved treasury management swap fees. Our outlook for customer-related non-interest income for the third quarter of 2024 is moderately increasing relative to the third quarter of 2023.

Regarding credit quality, classified loan levels are remaining stable and low. Non-performing assets increased $64 million due primarily to two suburban office loans in the Southern California market. These loans added $46 million, while one C&I loan is expected to be sold in the fourth quarter. The allowance for credit losses is 1.30% of loans, a 5 basis point increase over the prior quarter due largely to increases in reserves for the commercial real estate office portfolio.

This concludes our prepared comments. 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.

I wanted to ask about NII. When we look at the NII monthly data that you provided earlier in September versus what you have here for the full quarter, it looks like NII declined in September. So just wondering if you could talk about what drove that and how you're thinking about the path of NII between now and the stable outlook you outlined for 3Q '24?

I'll start. So the purpose of the monthly net interest income that we provided in both the second and the third quarter was meant to provide some inter-quarter guidance, which we don't typically do on this sort of level of where net interest income and the net interest margin was coming out. And so, you may recall at the end of the second quarter, during the second quarter call in July, we stated that we expected the net interest margin to begin to stabilize in the third quarter when compared to the second quarter after seeing several quarters of net interest margin decline, and that the net interest income outlook was meant to sort of support that. I wouldn't read too much into monthly net interest income figures. I think that can get a little tricky. I would rely on our overall outlook, which is that as we look ahead over the course of the next year, we expect our net interest income to be approximately flat in the third quarter of '24 when compared to the third quarter of '23.

Well, yes, I think there's also one fewer day in the month versus August. I mean, you'll get a little fluctuation for things like that as well.

I appreciate that. And just as we think through the trajectory for NII over the next year. In a high of a longer rate environment, I know you do get benefit from utilizing the securities paydowns as well as the loans repricing. But given the pressure on the deposit side, should we think about just NIM and NII maybe coming down a little bit in the near term and then starting to move up as we get closer to 3Q '24? Or maybe you can help us with the trajectory there.

Sure. I'll tell you how I'm thinking about it. And that is that, as the yield curve has steepened, we've seen a continued flattening that has occurred particularly over the last several months. Our earning assets are continuing to reprice. The earning asset pick-up, I expect it to be in the sort of range of 5 basis points to 10 basis points a quarter over the next couple of quarters. You also saw our funding costs, and the increase in our funding costs began to notably flatten out in the third quarter compared to where they were in the prior two quarters. My expectation, therefore, is that the improvement in earnings assets will keep pace with the change in funding costs such that, my expectation is that the net interest margin will not decline much from here, consistent with the outlook we provided in the second quarter.

Back on the NII guide, what are you guys factoring in for deposit flows, beta, and the bottom for the DDA mix and the timing of that, if you have got any thoughts around your base case there?

Yes. I don't have the slide number in front of me, but in the interest sensitivity slide in the materials, you will see that we actually provided an expectation of continued increase in deposit rates. You can see there that the outlook for deposit beta provides a total deposit beta of 50%, accumulating over time throughout the next year. That is, if interest rates stop rising, we are continuing to expect in that outlook for deposit rates to continue increasing marginally.

Good afternoon. I would like to ask about loan growth. I understand that your outlook for loan growth is stable, but I am curious if there might be potential for it to increase. We're observing that some banks under the $100 billion Basel III threshold are successfully gaining market share while larger banks are focused on their risk-weighted asset management and optimizing their balance sheets. Do you think there is a chance for you to seize quality loan growth that you might not have had before, or to increase your market share, suggesting that your loan growth outlook may be somewhat conservative?

John, I'll jump in. I've always believed loan growth is the trickiest thing possible to try and forecast because it’s so dependent on payoffs and rates. But there may be some upsides. I think none of us think it's going to be that we're going to see anything much, but there could be some. We also noted that during the third quarter, we observed pretty weak loan demand. I think very recently we've seen a little bit of a pick-up, but it's hard to make much out of a very short period of time in terms of trying to extrapolate that very far. So that's why we've got it kind of stable.

John, this is Scott. I would just add that whatever pulling back the global banks are doing, I don't know that it's producing a granular sort of benefit in the marketplace. Particularly when you think about the size of our clients and the size of their books, to the extent they're pulling back on large commitments, that's not necessarily where we play. But I would say that our loan flatness right now is more indicative of just the customer base being cautious compared to where they were 2, 3, 4 quarters ago.

Understood. Lastly, Paul, you indicated in the prepared remarks that the expense objectives have taken longer than originally planned to execute. Could you just talk about that or what has taken longer in terms of any expense rationalization efforts? And maybe if you could tie into that is the core system upgrades. Is that at all impacting that? Thanks.

Yes. I'll start and then turn it over to Scott and Harris to supplement that. You saw us take a severance charge in the second quarter. The run rate improvement associated with that is expected in the fourth to first quarter. But regarding taking longer than expected, I'm speaking about the inflation headwinds. We're seeing that across the board in contracts and other aspects. We continue to fight expenses actively. The reality of the environment we're all dealing with today is affecting us.

I would just add that the inflation in 2022, although it has softened this year, in terms of major technology vendors and their renewals, we have observed some of the most vigorous rate pass-throughs that we've seen in years. This is symptomatic of the fact that the inflation occurred last year, and costs are rising heading into '24.

They've all been watching streaming services, I think.

On our core transformation project, we have commented that when we go live with the final deposits release, we are now in the pilot phase with one of our affiliates. During this period, it will take us 12 months to fully convert all of our affiliates. Our P&L impact will worsen by about $10 million to $15 million during this period, and then in the following year, it'll drop by a commensurate amount. So there’s a timing issue related to the go-live period.

Paul, maybe we could come back to the deposit beta slide. I want to ensure I fully understand. I'm comparing your assumed full cycle beta last quarter of 40 to the new 50. I'm trying to reconcile the 70 basis points of additional deposit pressure from here. If the Fed's done, why would you see such a large increase in deposit costs from here?

Yes, so there's two things going on there. As I said, there's a lagging effect of deposit rates, and this is what we're assuming in the model. I'm hopeful we can do a little better than this. But based on recent history, our expectation is that interest-bearing products will continue to float up. A big part of that is an assumption of the continued migration of non-interest bearing demand into interest-bearing deposits, which has an economic effect similar to a repricing beta. So all of these factors combine into that 70 basis points.

Maybe separately, I think John asked about the growth opportunity under $100 billion. You're about 10% or 15% under this threshold. I'm interested in the costs that you're beginning to budget. One of your peers said it's $100 million a year from crossing. You have time to remix and stay under. But how are you thinking about the costs to ultimately go over $100 billion?

Recall we were a CCAR bank a few years ago, and all of the compliance measures are still in place. I don't foresee anywhere close to $100 million of incremental cost. I think we have the systems in place to comply. The biggest change for us will be the incorporation of AOCI into the numerator of capital. However, the relatively short duration of our investment portfolio will largely mitigate that impact by the time those rules become effective for us.

That's true with respect to capital. The main area where costs will arise is with debt requirements. We've got about $0.5 billion of debt, but if the proposed debt requirement is implemented today, that would increase to about $4 billion. That incremental $3.5 billion additional debt will create some drag when you think about the cost of funding compared to our risk-weighted assets.

Good evening. With the expectation of stable loans over the next 12 months and the runoff of the securities book, what's the outlook for deposit growth?

We have historically stayed away from deposit growth outlooks. However, what you have seen over the last couple of quarters is substantial deposit growth. Our ongoing conversations with customers have resulted in an increase in deposits on the balance sheet. Deposit growth has been very good, particularly in the third quarter. I do not expect that level of deposit growth to continue, but I believe Zions will maintain a strong loan-to-deposit ratio and continue to see deposit growth into the next quarter.

Is there a meaningful difference between the rate on new customer deposits versus existing customers?

Yes, the deposit growth we've seen in the third quarter has definitely come from higher deposit offering rates for new money coming on the balance sheet at higher rates.

I would say that we've seen an active response from clients as we have become more aggressive in pricing interest-bearing deposits. As we have mentioned, we had approximately $11 billion in deposits off balance sheet. As we've continued to engage with those clients about bringing those deposits back, it has been a productive conversation, and we’ve managed to capture deposits not only from our off-balance sheet money market sweeps but also from clients at other institutions.

I wanted to follow up on the fixed asset repricing commentary. If I heard you correctly, I think you said it was 5 basis points to 10 basis points a quarter, positive to the earning asset yield over the next couple of quarters. Can you unpack that a little for us and explain the assumptions driving that? What's the amount of loans that are repricing over the next 12 months and what's the back book yield that’s coming off versus new origination yields?

Yes, I'm going to answer that slightly differently. We have a sophisticated balance sheet simulation tool analyzing our loans and securities on a note-by-note basis. We input the forward curve and evaluate the results for the next few quarters. What we see is that the earning asset yield, in the aggregate, including cash flows from investments, provides an increase in yield for earning assets in the range of 5 to 10 basis points over the next couple of quarters.

Regarding shared national credits, the total proportion of our loan portfolio is in the range of 10% to 15%. Of that, we lead about 10% to 15% of what we participate in, and our portfolio is balanced and has performed well for us over the years. The two office loans in question were located in Southern California, and they faced leasing rollover issues as they couldn't re-tenant as quickly as expected.

Thank you, Alicia. And thank you to all for joining us today. If you have additional questions, please contact us via 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.