Ryan Richards
Chief Financial Officer at Zions Bancorporation, National Association
Thank you, Harris, and good evening, everyone. I will begin with the discussion of the components of pre-provision net revenue. Slide 6 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 is reflected on the bars and net interest margin as shown on the white boxes. Both measures reflect improvement for three consecutive quarters as the repricing of earning assets outpaced the increase in funding costs. We also continue to benefit from favorable changes in asset mix on our balance sheet.
Additional details on changes in the net interest margin are included on Slide 7. On the left-hand side of this page, we provide a linked-quarter waterfall chart, outlining the changes in key components of the net interest margin, incorporating changes in both rate and volume. Net interest margin expanded by 5 basis points sequentially, driven by higher earning asset yields and improved mix. This is reflected in the 2 basis point and 3 basis point margin improvements in the waterfall attributable to money market insecurities and loans, respectively.
Funding component effects were offsetting as the benefits associated with the reduced short-term borrowing costs were offset by a slight increase in the average cost of interest-bearing deposits and a lesser contribution to profitability from noninterest-bearing deposits. Right-hand chart on this slide shows the net interest margin in comparison to the prior year quarter.
Higher rates were reflected in money market, securities and loan yields, which contributed an additional 34 basis points to the net interest margin. These positive contributions were somewhat offset by increased deposit costs, higher borrowings, and declines in the value of our noninterest-bearing deposits to the balance sheet. Overall, the net interest margin increased 10 basis points versus the prior year quarter.
Moving to non-interest income and revenue on Slide 8. Customer-related non-interest income was $161 million compared to $154 million in the prior quarter, largely driven by a $7 million increase in capital market fees that Harris alluded to previously. We remain optimistic that our expanding capital market focus will allow us to grow fee income meaningfully moving forward. Our product offering enables us to address a full complement of risk management and strategic needs of our customers. Our outlook for customer-related non-interest income for the third quarter of 2025 is moderately increasing relative to the third quarter of 2024.
The chart on the right side of this page includes adjusted revenue, which is the revenue included in the adjusted pre-provision net revenue and is used in our efficiency ratio calculation. Adjusted revenue increased from both prior quarter and year ago periods due to the factors previously noted for net interest income and customer-related fee income.
Adjusted non-interest expense shown in the lighter blue bars on Slide 9 decreased $7 million to $499 million, attributable largely to decreases in legal and professional services, FDIC premiums and salaries and employee benefits, excluding severance. Reported expenses at $502 million also decreased by $7 million compared to the prior quarter. Our outlook for adjusted non-interest expense for the third quarter of 2025 is slightly increasing relative to the third quarter of 2024. Risks and opportunities associated with its outlook include our ability to manage technology costs, vendor contractual increases, and employment costs.
Slide 10 highlights trends in our average loans and deposits over the past year. On the left side, you can see that average loans increased slightly in the quarter. As Harris noted previously, we believe that customer optimism has improved in response to the recent rate reduction and the expectation that rates will continue to move downward in the near term. Our guidance is that loans will be stable to slightly increasing in the third quarter of 2025 relative to the third quarter 2024. We expect this growth to be led by our commercial portfolio and offset somewhat as commercial real estate and residential mortgage loans are expected to refinance as rates decline.
Now turning to deposits on the right side of this page. Average deposit balances for the third quarter increased modestly, while average noninterest-bearing deposit balances declined slightly. The cost of total deposits shown in the white boxes increased 3 basis points to 2.14%. We were encouraged by the trending in interest-bearing deposit costs during the quarter, with the blended spot rate declining to 2.94% at September month end compared to 3.19% for the quarter and 3.2% for the prior quarter. As a reminder, about one-third of our deposits were priced at or above benchmark rates prior to the rate cut. We are seeing a near 100% beta on those higher cost deposits so far. We anticipate this trend will continue over the next few rate cuts.
Slide 11 includes a more comprehensive view of funding sources and total funding cost trends. The left side chart includes ending balance trends. Compared to the prior quarter, customer deposits increased slightly. Period end noninterest-bearing deposits grew 1% and were 33% of total deposits. On the right side, average balances for our key funding categories are shown along with the total cost of funding. As seen on this chart and previously noted, the total funding costs remained flat sequentially.
Moving to Slide 12. Our investment portfolio exists primarily to be a storehouse of funds to absorb customer-driven balance sheet changes. On this slide, we show our securities and money market investment portfolios over the last five quarters. Maturities, principal amortization and pre-payment related cash flows from our securities portfolio were $752 million in the third quarter. The paydown of lower-yielding securities continues to contribute to the favorable remix of our earning assets as well as a means to manage down our wholesale funding costs. Duration of our investment portfolio, which is a measure of price sensitivity to changes in interest rates, is estimated at 3.6%.
Transitioning to Slide 13, we believe that net interest income in the third quarter of 2025 will be slightly to moderately increasing relative to the third quarter of 2024. Risks and opportunities associated with this outlook include realized loan growth, competition for deposits and depositor behavior, and the path of interest rates across the yield curve.
While we've provided standard parallel interest rate shock sensitivity measures on Slide 28 in the appendix of this presentation, we present here our view of interest rate sensitivity assuming interest rates follow the path implied on September 30. Modeled net interest income in the third quarter of 2025 is expected to be 1.4% higher when compared to the third quarter of 2024. This includes the impact of both latent and emergent sensitivity that we have broken out in prior quarters.
As expectations on the rate path continue to evolve, we also provide 100 basis point shocks to the rates implied by the forward path, which suggests a sensitivity range between negative 0.8% and positive 3.1%. As a reminder, this is a model view of rate sensitivity based on relatively static assumptions. It does not include management's view of balance sheet changes, pricing strategies and other strategic factors included in our net interest income guide.
Moving to credit quality on Slide 14. Realized losses in the portfolio continue to be low with annualized net charge-offs of just 2 basis points of loans in the quarter and 6 basis points over the last 12 months. While we are pleased with this outcome, we don't expect to continue to operate at this abnormally low level of charge offs.
Harris alluded to some of the credit metrics earlier on this call. We experienced further deterioration of credit quality during the quarter. Non-performing assets increased $103 million to $306 million [Phonetic] and now represent 62 basis points of loans and other real estate owned. Increase was driven by a small number of C&I and commercial real estate credits. Classified and criticized loan balances increased by $829 million and $426 million, respectively, due to the reasons Harris noted in his opening remarks. A declining rate environment will ultimately benefit risk rates on CRE lending, but grade improvement will be gradual as we require seasoning of credits in the portfolio before we consider upgrades. The allowance for credit losses increased 1 basis point over the prior quarter to 1.25% of total loans and leases.
As we know it is a topic of interest, we have included information regarding the commercial real estate portfolio with additional detail included in the appendix of this presentation. Slide 15 provides an overview of the $13.5 billion CRE portfolio, which represents 23% of total loan balances. The portfolio is granular. We have managed this growth carefully over a decade.
Slide 16 provides a detailed view of the problem loans in our CRE portfolio. The chart on the right-hand side provides a breakout of which subportfolios drove increases in criticized and classified assets during the quarter. Of the $829 million increase in classified loans, $442 million was driven by multi-family apartment credits. The chart on the bottom left-hand side of this slide reflects the LTV distribution of classified CRE loans with the preponderance of loans showing estimated LTVs of 70% or less. Overall, we expect the CRE portfolio to perform reasonably well with limited losses based on the current economic outlook, the types of problems being experienced by the borrowers, relatively low loan-to-value ratios and continued sponsor support.
Our loss-absorbing capital is shown on Slide 17. The CET1 ratio continued to grow in the third quarter to 10.7%. This, when combined with the allowance for credit losses, compares well to our risk profile as reflected in the low level of ongoing loan net charge offs. We expect our common equity from both a regulatory and GAAP perspective to increase organically through earnings and that AOCI improvement will continue through natural accretion of the securities portfolio as individual securities pay down and mature.
Slide 18 summarizes the financial outlook provided over the course of this presentation. As a reminder, this outlook represents our best estimate for the financial performance for the third quarter of 2025 as compared to the third quarter of 2024. With this outlook, we expect to see positive operating leverage and improved efficiency as revenue growth outpaces funding and expense pressures.
