Zions Bancorporation, National Association Q2 2023 Earnings Call Transcript

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July 19, 2023

There are 9 speakers on the call.

Operator

And welcome to Zions Bancorp Q2 Earnings Call. At this time, all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Shannon To Rade, Director of Investor Relations.

Operator

Thank you, Shannon. You may begin.

Speaker 1

Thank you, Alicia, and good evening. We welcome you to this conference call to 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.

Speaker 1

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 Virtis, our Chief Financial Officer, will review our financial results. Also with us today are Scott MacLean, President and Chief Operating Officer And Keith Mayo, Chief Risk Officer.

Speaker 1

After our prepared remarks, we will hold a question and answer session. This call is scheduled for 1 hour. I will now turn the time over to Harris Simmons.

Speaker 2

Thanks very much, Shannon, and we welcome all of you to our calls this evening. We're pleased that the environment around the banking industry seems to have stabilized relative to the disruption we saw during the Q1. 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 designs this quarter as well as those that are likely to be prominent over the near term horizon.

Speaker 2

Customer deposits were up $2,000,000,000 for the quarter. We are grateful but not 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 is ready. We are also committed to managing our expenses in relation to a more challenging revenue environment. Our second quarter results reflect a $13,000,000 severance expense related to our objective of flattening expenses over the next year.

Speaker 2

Our levels of non performing and criticized assets declined slightly compared to the prior quarter. We experienced $13,000,000 net charge offs, higher than the Q1, but well below historic norms and reflective of 1 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 Q1 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 Q1.

Speaker 2

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 $13,000,000 of severance expense. Offsetting that was an equal positive impact from the gain on the sale of a piece of property.

Speaker 2

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 2nd quarter adjusted pre provision net revenue was $296,000,000 The linked quarter decline was attributable to the primary factors I've just noted and was slightly down compared to the year ago quarter.

Speaker 2

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?

Speaker 3

Thank you, Harris, and good evening, everyone. I'll begin with a discussion of the components of pre provision net revenue or PPNR. Over 3 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 The chart on the left shows the recent 5 quarter trend for both. Net interest income on the bars And the net interest margin in the white boxes declined in the 2nd 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.

Speaker 3

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 non interest bearing funds. As noted on prior calls, we have been more competitive with deposit pricing, a tactic that has accelerated in the 2nd 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 Q2 and non interest bearing sources of funds continue to serve as a significant contributor to balance sheet profitability.

Speaker 3

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 And the value of non interest bearing funds was almost entirely offset by increased deposit and borrowing costs. Our outlook for net interest income in the Q2 of 2024 is stable to slightly decreasing relative to the Q2 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.

Speaker 3

Moving to non interest income and revenue on Slide 9, customer related non interest income $162,000,000 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 Q3 of 2022, which has reduced our non interest income by about $3,000,000 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 Q1, Customer fees grew $11,000,000 or 7% due to strength in loan syndications, interest rate derivative sales And other capital markets activity. Our outlook for customer related non interest income for the Q2 of 2024 is moderately increasing relative to the Q2 of 2023.

Speaker 3

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 Q1 due to the factors noted previously. Adjusted non interest expense shown in the blue bars on slide 10 decreased 3% from the prior quarter to $494,000,000 The Q1 typically includes seasonal items such as stock based compensation for retirement eligible employees and payroll taxes. And the Q2, therefore, reflects a decrease due to the lack of those seasonal expenses. Reported expenses at $508,000,000 Includes $13,000,000 in severance expense associated with our intent to flatten expenses over the next year.

Speaker 3

Our outlook for adjusted non interest expense is stable in the Q2 of 2024 when compared to the Q2 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 In the Q2 of 2024 when compared to the Q2 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.

Speaker 3

And while average deposits for the 2nd quarter were down slightly, Ending balances grew 7% compared to the end of the Q1. Customer deposits excluding brokered deposits grew 3%. As noted previously, our deep customer relationships enable 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 Q4 of 2021, the repricing beta on total deposits Based on average deposit rates in the Q2 was 25% and the similar measure for interest bearing deposits was 43%.

Speaker 3

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 non interest bearing funds has on the net interest margin. Slide 12 shows non interest 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 As the chart on the left shows, we reported a notable increase in uninsured deposits throughout 2020 2021 And as been previously reported, the level of uninsured deposits has been falling back toward historical levels.

Speaker 3

During the Q2, 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.

Speaker 3

On this slide, we show our securities and money market investment portfolios over the last 5 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 $900,000,000 in the 2nd 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.

Speaker 3

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 1 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.

Speaker 3

During the Q2, dollars 2,500,000,000 of receipt fixed interest rate swaps were canceled and $2,500,000,000 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.

Speaker 3

Assuming a funding cost beta based on recent history, We would expect net interest income to decline approximately 4% in the Q2 of 2024 when compared to the Q2 of 2023. Regarding emergent sensitivity, if the June 30, 2023 forward curve which for passive 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 Q2 of 2024 when compared to the Q2 of 2023. As noted previously, our outlook for net interest income for the Q2 of 2024 Relative to the Q2 of 2023, it's 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.

Speaker 3

The CET1 ratio continued to grow in the Q2 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 Q3. 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.

Speaker 3

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 changing 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 percent 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 details around the commercial real estate portfolio, 23% of our total portfolio with office representing 17% of total CRE or 4% of the total loan balances.

Speaker 3

Credit quality measures for this total CRE portfolio remain 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 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 Q2 of 2020 as compared to the actual results reported for the Q2 of 2023.

Speaker 3

The quarters in between are subject to normal seasonality.

Speaker 1

This concludes our prepared remarks. As we move to the question and answer section of the call, we request that you limit your Alicia, please open the line for questions.

Operator

Thank you. We will now be conducting a question and answer A confirmation tone will indicate your line is in the question Our first question comes from Mahan Ghazalia with Morgan Stanley. Please proceed with your question.

Speaker 4

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 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.

Speaker 3

Yes. This is Paul. If I could, I might point you to in the appendix of our presentation, forgive me, I'm trying to find In the appendix of our presentation on Page 22, we're providing monthly trends in net interest income And then you can see the net interest margin there as well as non interest bearing demand deposits. And I think what you see there to your question, I think what you see there It's a flattening of those trends, which is informing our outlook.

Speaker 4

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 Funding returns, how much more room is there for further expense cuts either through ongoing expense saves Or cuts in non core businesses?

Speaker 3

Sure. This is Paul. I'll start with that response. I am reluctant to quantify the specific expense associated with the severance because the it's It's part of a much larger program and the larger program is meant to create a non interest expense level a year from now, Which is roughly consistent with the current

Speaker 2

quarter and

Speaker 3

that 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 We're going to have to manage through to the extent those possible changes might occur.

Speaker 4

Great. Thank you.

Speaker 3

Sure. Thank you.

Operator

Our next question comes from John Pancari with Evercore ISI. Please proceed with your question.

Speaker 5

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

Speaker 3

Well, the mix the issue with the ratio, of course, I have two numbers. And as I noted, we are having success growing interest bearing deposits. And so it's hard to provide sort of a specific kind of bottom to that ratio Because it's taken in the context of total deposits, but also the macroeconomic sort of environment has a very large effect. If interest rates were spike up again from here, we would probably continue to see pressure there. What I can say though is that our outlook sort of our best Estimate for where we think net interest income is going to be a year from now versus today incorporates Some additional migration in DDA out of non interest bearing and into interest bearing.

Speaker 3

And so that's all implied in sort of Those beta figures that I was referring to. And so I think from my perspective, the thing to keep an eye on is The behavior of total deposit costs and how that's affecting net interest income over time. So we've lost, As you know, over $10,000,000,000 of demand deposits over the last year, my expectation is that we wouldn't Under our sort of baseline assumptions, we wouldn't lose nearly that much over the next year. Absent a lot of further increase in rates.

Speaker 6

Hey, John, this is Scott. The slide that Paul just pointed out, Slide 22, it shows this is always just focused on Declining DDA in a period of rising rates, but the demand deposits become worth more also. And I think that's what that slide depicts. Clearly, non interest bearing is lower, but they're worth more than they were a year ago and It has very favorable influence. The other thing I would say is that When you look at our mix of VDA, which you're talking about, the total deposits Through back 2 decades now, more than 2 decades, we've always had a competitive advantage In terms of our mix of non interest bearing to total deposits, that slide is in the deck also in the appendix.

Speaker 6

And Slide 25, and we don't anticipate that that relationship that's existed for Over 2 decades will change materially in terms of our competitive advantage versus our peers through many different interest rate environments because It's clearly a function of our strategy of banking businesses and the type of deposits they have with us, which are small granular

Speaker 5

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 3rd quarter.

Speaker 5

Just give us an update, what could change that? What could bring it back in the market for your shares here? Thanks.

Speaker 3

I'll 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 more clear, The capital sort of regulatory rules become more clear, 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.

Speaker 5

Great. Thanks for taking my questions.

Speaker 3

Thanks, Ron.

Operator

Our next question comes from Steven Axtopoulos with JPMorgan. Please proceed with your question.

Speaker 7

Hi, everybody. Hi, Steve. I wanted to start. So looking at, 1, the growth of broker deposits and then 2, 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?

Speaker 6

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 and jolt to the marketplace. And I think what we tried to demonstrate through March and into the Q2 Was the ability to utilize broker deposits, which we did over the short term period March, April, that time period. And but then we were also pulling on the level of our higher priced commercial sweep products And reciprocal deposits.

Speaker 6

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 3. We're seeing, as you noted and as Paul noted, Good progress in building customer deposits, those 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 The system, I think pretty confident that's what you'll see over the next 6 months.

Speaker 3

Yes. The other thing I'll note is those brokered CDs are in a sort of a laddered format. So, they've got An average maturity of about 6 months. So there's an opportunity, as Scott said, to replace them as we're able to grow customer

Speaker 6

I think another important point, Stephen, is the growth in interest bearing deposits We didn't just start talking to our customers about their liquidity and the rates we pay for that. If you go back to 2021, 0 interest rate environment. We were pushing clients. We were recommending to them that they move their deposits off our balance sheet. We entered the quarter with about $12,000,000,000 in off balance sheet deposits, customer deposits, and we had recommended that they do that because Money market funds, we're going to pay more than the banking industry.

Speaker 6

So when we started more actively in February March and into the second quarter, Talking to our clients about our on balance sheet rates, it wasn't like that was the first time we talked to our customers about their liquidity. They were, generally speaking, happy to bring them back on balance sheet and that we think That trend will continue as we have become more aggressive about our pricing of short term deposits.

Speaker 7

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 yield at only 5.65 How far away are we from your NIM troughing?

Speaker 3

Sorry, I just want to clarify on the question from a troughing. Thank you, Trophe. That was the word I missed. So, when you consider our outlook, Which is kind of flat to slightly decreasing net interest income. And you consider that in the context of What I might describe is somewhat tepid loan growth combined with an investment portfolio, which is going to continue to pay down.

Speaker 3

Again, we had nearly $1,000,000,000 Pay downs this quarter. My expectation is earning assets, generally speaking, are going to be kind of flat to down. So when you put those two things together, the revenue as a numerator and earning assets as a denominator, I actually think we're getting My point of view, I think we're getting pretty close to, again, barring some unforeseen event, I think we're getting pretty close to the lower Edge 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 quarterly average.

Speaker 2

Okay. Also, The cost of interest bearing deposits was 2.22% during the quarter. If you exclude The broker deposits it was 1.62. So I mean to your point to the extent we bring additional customer money back on. I mean, it's what we're bringing back on is certainly costing more at the margin than the average, but There's additional room to bring that down a little bit.

Speaker 7

Thanks for taking my questions.

Speaker 6

Thanks, Steve.

Operator

Thank you. Our next question comes from Chris McGratty with KBW. Please proceed with your question.

Speaker 8

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

Speaker 3

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

Speaker 2

Correct.

Speaker 8

Yes.

Speaker 3

Yes. So, if I could point you back to the page, I don't have the page in front of me, but we have a page in the slide deck around Risk specifically and around the modeled outcome. I'll note again that we've got 2 sets of bars there. The second set of bars is what we're calling the sort of adjusted assumptions, because what we've observed is deposit betas, Which have exceeded expectations based on our models for a lot of reasons. It's on Page 15 of the slide deck.

Speaker 3

So, I think the most important as you're thinking about sort of looking ahead, I think the most important measures to consider are The betas that we've realized since the beginning of 2022 And then considering that our net interest income outlook is incorporating the sort of the most Current view on beta, which is effectively very close to the beta that we've actually realized since the beginning of 2022.

Speaker 8

So if I look at the standard versus adjusted on that Slide 15 there, It's really just increased beta is the only is also a dynamic mix shift like further shifts from non interest to interest bearing or So it's really just a higher beta.

Speaker 3

Yes. Incorporated in our when I say beta, incorporated in our beta, that's not only the rate of change in non interest bearing deposits, But incorporated in there is some shift from non interest bearing deposits to interest bearing deposits.

Speaker 8

Okay. And then maybe just pay downs 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.

Speaker 3

Well, I said it in the script. It is actually in the slide deck. And I said it in the script, the pay downs We're just over the net paydowns were just over $900,000,000 in the current quarter, and they've ranged kind of between $750,000,000 and $1,000,000,000 over the course of the last several quarters.

Operator

Thank you. There are no Further questions at this time, I would like to turn the floor back over to Shannon for closing comments.

Speaker 1

Thank you, Alicia, and thank you We look forward to connecting with you throughout the coming months. Thank you for your interest in Zions Bank Corporation. This concludes our call.

Operator

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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Zions Bancorporation, National Association Q2 2023
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