Paul E. Burdiss
Chief Financial Officer at Zions Bancorporation, National Association
Thank you, Harris, and good evening, everyone. I'll begin on Slide 7. A significant highlight for us this quarter was the strong performance in average loan growth. Average non-PPP loans increased $1.5 billion, or 2.9% when compared to the second quarter. Areas of strength included commercial and industrial, residential mortgage and both commercial and consumer construction as can be seen in the appendix on Slide 30.
The yield on average loans increased 50 basis points from the prior quarter, which is primarily attributable to increases in interest rates. Average PPP loans declined $393 million to $408 million. Excluding PPP loans, the loan yield improved 55 basis points to 4.16% from 3.61%. Deposit costs increased during the quarter, but remained low. Shown on the right, our cost of deposits rose from 3 basis points to 10 basis points in the third quarter. That's cost of total deposits. Our average deposits declined $3.4 billion or 4.2% linked quarter.
For deeper insight into deposit volume changes, please turn to Slide 8, where we break down our deposits by size. As shown here, the majority of our deposits come from relationships holding less than $10 million on our balance sheet. Digging deeper into deposit runoff, you can see on this chart that the 2022 decline in deposits has come from large balance low activity accounts. In our experience, these deposits are the most rate sensitive. Therefore, the faster-than-expected increase in rates and the widening differential in our deposit rates paid when compared to other investment products has created an incentive for some of these large less operationally active dollars to move off of our balance sheet. Where possible, we have actively managed these funds into off-balance sheet products maintaining the relationship with the customer while keeping deposit costs well managed.
Contrary to the trends in large balance deposits, deposit relationships with clients holding under $10 million with us have generally been stable since the beginning of the year. Combined with the third quarter's loan growth, our loan-to-deposit ratio remains a very comfortable 71%, which is still about 15 basis points below the level just prior to the pandemic.
Moving to Slide 9, we show our securities and money market investment portfolios over the last five quarters. The size of the securities portfolio declined by $2 billion over the previous quarter, driven by an adjustment to the fair value, no new security purchases and repayments of about $900 million. The combination of securities and money market investments is now 34% of total earning assets at period end, which remains above our pre-pandemic average of 26%. Excluding fair value marks, we anticipate that money market and investment securities balances combined will continue to decline over the near term. Our revenue is primarily balance sheet-driven. This quarter, 80% of our revenue comes from net interest income.
Slide 10 is an 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 reflects both loan growth and higher interest rates, while the net interest margin in the white boxes also reflects a remixing of earning assets in the last two quarters toward higher-yielding assets. We attempt to quantify the impact of these trends on the net interest margin on the right-hand side of that page.
Slide 11 provides information about our interest rate sensitivity. Due to the rapidly changing environment, recall that last quarter, we introduced the terms latent interest rate sensitivity and emergent interest rate sensitivity. Regarding latent sensitivity, rate changes that were in place as of September 30, we will work through our balance sheet and income statement over the near term and should add approximately 10% to our net interest income in the third quarter of 2023 when compared to the third quarter of 2022.
Regarding emergent sensitivity, if the forward path of interest rates were to materialize, we would expect an additional 3% in net interest income in the third quarter of 2023 when compared to the third quarter of 2022, in addition to the 10% increase from latent sensitivity. The forward path is defined as the forward yield curve as of September 30, which at that time included about another 150 basis point increase in the Fed funds target rate. Both measures assume that earning assets will remain flat and that non-specific maturity deposits will move and reprice in accordance with our interest rate risk modeling assumptions. In other words, and for example, loan growth would be expected to add to net interest income beyond the latent and emergent sensitivity estimates, which consider only changes in interest rates, while the investment portfolio attrition would be expected to narrow these figures.
With respect to our traditional interest rate risk disclosures, our estimated interest rate sensitivity to a 100 basis point parallel interest rate shock has declined by 2 percentage points from the second quarter and about 8 percentage points from the beginning of the year. This change reflects the recent decline in deposits, an increase in our interest rate swaps portfolio and a higher net interest income denominator. In summary, we expect latent and emergent interest rate sensitivity, combined with continued loan growth and manageable changes in deposit volume and pricing, to continue to increase net interest income over the coming year.
Moving on to non-interest income and total revenue on Slide 12. Customer-related non-interest income was $156 million, an increase of 1% over the prior quarter and 3% over the prior year. As we noted in July, we have modified our non-sufficient funds and overdraft fee practices near the beginning of the third quarter, which reduced our non-interest income by about $2 million in the quarter. Improvement in customer-related fee income are fairly broad-based. And when combined with the changes in revenues associated with our deposit products produces an outlook for customer-related non-interest income in the third quarter of 2023 of slightly increasing compared to the current quarter, up from the prior quarter's outlook of stable.
The right side of that slide, revenue shows the sum of net interest income and customer-related non-interest income. Revenue grew by 16% from a year ago when excluding PPP income, grew by 26% over the same period. We expect client activity and the positive impact of higher interest rates to continue to improve this measure over the coming quarters.
Non-interest expense on Slide 13 increased 3% from the prior quarter to $479 million. Salaries and benefits grew by $5 million. The primary drivers include the additional staffing and an extra day in the quarter compared to the second quarter. We continue to feel the impact of inflation, which is showing in smaller but numerous increases in several other expense categories. Our outlook for adjusted non-interest expense is to moderately increase by the third quarter of 2023 when compared to the third quarter of 2022.
Another highlight for the quarter was the continued strong credit quality across the loan portfolio, as illustrated on Slide 14. Relative to the prior quarter, we saw continued improvement in the balance of criticized and classified loans. Net charge-offs to average loans for the quarter was 21 basis points of average non-PPP loans compared to a loss rate of only 7 basis points in the prior quarter. Credit losses this quarter could best be described as unique situations rather than systemic or common theme losses. Notably, our non-performing asset ratio and classified loan ratio continued to improve and are at very healthy levels.
Slide 15 details the recent trend in our allowance for credit losses, or ACL, over the past several quarters. At the end of the third quarter, the ACL was $590 million, a $44 million increase from the second quarter. A little over half of the linked quarter ACL increase can be ascribed to the buildup of reserves on existing non-PPP loans, up from 5 basis points -- I'm sorry, up 5 basis points from the prior quarter to 1.10% with the remaining increase attributable to growth in the loan portfolio. Our ACL will continue to reflect the size and composition of our loan portfolio and evolving macroeconomic forecasts.
Our loss absorbing capital position is shown on Slide 16. We believe that our capital position is aligned with the balance sheet and operating risk of the bank. The CET1 ratio fell in the third quarter to 9.6%, as strong loan growth outpaced retained earnings. We repurchased $50 million of common stock in the third quarter. As a reminder, share repurchase and dividend decisions are made by our Board of Directors, and as such, we expect to announce any capital actions for the fourth quarter in conjunction with our regularly scheduled Board meeting this coming Friday. Our goal continues to be that the CET1 capital ratio will remain at or slightly above peer median while managing to a below-average risk profile.
Slide 17 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 third quarter of 2023 as compared to the actual results reported for the third quarter of 2022. The quarters in between are subject to normal seasonality.
This concludes our prepared remarks. Sherry, would you please open the line for questions?
