We're gonna get started. Just make sure my microphone's on. Up next, we're pleased to have Zions Bancorporation joining us again at the conference. Zions has navigated a challenging environment well by maintaining a tight control on expenses, moved quickly to shore up its funding, and maintain strong capital ratios. Here to tell us more about the story is Chairman and CEO, Harris Simmons. Harris, you're gonna walk through some slides, and then we're gonna get into a discussion.
Yeah, I'll briefly go through a few slides and then try to get to questions as quick as we can. A lot of you know us. We operate under local brand names as a, actually kind of a publicly traded national bank. We don't have a holding company, but have actually a reasonably simple structure. But we operate with local brand names in markets across the West, from Texas up to Pacific Northwest, everything south and west of that. About $87-$88 billion in total assets. We've had very good credit results in recent quarters, and that's holding in well.
Largely commercial organization, very commercially oriented, and I think we have a really fabulous franchise, particularly with a lot of small and mid-sized businesses. You can see here what's happened with average loan deposit balances over the last few quarters. You know, loans been growing, although that's slowing quite a lot recently. Average total deposits, you can see in the first quarter, took a big dip. It's recovered nicely from the SVB crisis, although at a cost, as we've seen across the industry. Ending deposits and again, some of the same kind of information, but you can see that, and we repaired kind of an immediate hole with a lot of deposit flight from very large depositors, with broker deposits and borrowings.
We've been now paying that down and expect that to normalize here as we get into 2024. The, you know, total customer deposits include about $6 billion today of reciprocal deposits, one of the mechanisms we use to try to bring deposits back on balance sheet. If you look at net interest income, it was adversely affected by this. What we thought was gonna be a very nice 2023 with a very predictable, you know, building deposit beta was, we had kind of a step function change in that in in March.
So that's impacted margins, but it's stabilized and we expect it, you know, month-over-month, quarter-over-quarter, you'll see some variation, but we think we're in a pretty stable place right now. If you look at the fee income, it's been reasonably stable. We're seeing some growth in wealth management. Capital markets are some areas that we're focused on. Total revenue is down because of the margin compression. And so we're, you know, we're currently running quarterly adjusted revenue, taking out unusual items, about $765 million. Expenses, you know, we saw some increase with coming out of the pandemic, higher labor costs, et cetera, but we've been working to keep that reasonably flat.
We think it'll be pretty, pretty modest growth in 2024. We've reduced headcount by about 3% here in the fourth quarter, and that'll be helpful as we come into the next year. Credit quality, as I mentioned, is in very good shape. We've seen a very slight tick-up in non-performing assets, classified loans, et cetera, but nothing that really moves the needle. And charge-offs have been really well behaved, and we expect that will remain the case here in the next, you know, over the near term. We've been building the allowance. We're up about 1.3%, which relative to charge-offs is we think a reasonably conservative place to be.
A lot of questions in the industry today about commercial real estate, about office in particular. The total portfolio is about $13 billion. Office is about $2.1 billion. And so far, so good. We've had less than $5 million in net charge-offs in the office portfolio so far this cycle. And we think that's... We don't see that getting out of control anytime in the immediate future. I think it's gonna be, you know, it's gonna take a couple of years to really understand the office story, but it's not something that's really keeping us awake at night. I think with that, we will jump into some questions. So,
Thanks, Harris. Maybe to just jump in, you know, I think you said 2023 didn't really end up playing out the way that we think... most of us expected when we're sitting here last year. So as you look back on the events of the year, what are some of the key lessons learned, and how is it impacting the way that you run the bank going forward?
You know, I think we absolutely came to appreciate the importance of planning and preparation. I think in terms of liquidity, I'm really proud of what we did. We were able to quickly replace some of this immediate, you know, large deposit departures with, you know, in the repo market. You know, we had a lot of collateral pledged at not only Home Loan, but the Fed. We were, you know, we tested lines. We were able to repo securities, and so liquidity was never an issue. I think it made us appreciate the importance of doubling down, refocusing on smaller businesses, middle market, smaller middle market kinds of businesses with operating accounts.
The granularity of a deposit base became really important, and the value of it becomes clearer as you go through an experience like this.
So you mentioned, you know, refocusing on small business. Small business activity has obviously slowed a decent amount over the past few quarters. Can you talk about what you're seeing from your small business customer base in terms of activity and their willingness to borrow?
It's really slow right now. I mean, they're you know, I think they're being really cautious. I think it's a function of rates, you know, higher interest rates, spending down cash, and just you know, they've been reading about the looming recession for now a couple of years. And you know, I think it's taking a toll. You know, concerns about consumers, savings drying up, et cetera, et cetera. So for whatever reason, it's probably all the above. We're not seeing very robust demand, borrowing demand.
I guess more broadly, when you think about... I think the last time we heard from you, we were talking about something like relatively stable. Maybe just as you think about across the portfolio over the next four or five quarters, you know, what, what are some of the puts and takes? Where are you actually seeing opportunities? And then second, what would it take for you to be a bit more upbeat on the lending opportunity?
Well, I think, you know, where are we seeing opportunities? You know, fundamentally, across the board, it's pretty slow.
Yeah.
Commercial real estate, for all the obvious reasons, office retail, multifamily is showing some a little bit of softening in some markets. And so I, you know, I expect that that's going to be a little slower. And you know what? I mean, frankly, the growth we've seen has been, to some extent, been draws on construction commitments,
Mm-hmm.
... funding up, and we've seen a little bit of commercial growth, but it's pretty anemic. So I think it's gonna take a little more clarity, probably, and probably if we see some, you know, rates come down a little bit without the economy tanking, I think that's gonna be helpful.
Maybe thinking about deposits. So after you talked about the importance of liquidity after seeing outflows earlier in the year, you returned to customer growth, I think, over $3 billion in the prior quarter. How are you thinking about deposit growth going forward? Are there more opportunities to bring balances back that left onto the balance sheet, and you think we're now returning to sustained deposit growth for Zions?
Yeah, I mean, there's some... You know, I expect we'll see some additional deposit growth this quarter. And, I think, you know, going forward, it's really going to be a function of loan demand. I mean, we have a securities portfolio that's throwing off about $3 billion a year. I mean, we could... You know, I think we're going to be in a pretty comfortable place in terms of where deposits are. It's going to be driven ultimately by a resumption of loan demand before we have to go out and get particularly competitive again. I mean, we're, you know, we're having to be competitive with larger accounts, and everything's adjusted upward, but I think we're probably close to the end of that act in the play.
Maybe thinking about net interest income. We saw some encouraging signs, improvement early in the third quarter, and then it appears that it retrenched a little bit in September. I know one month doesn't make a trend, but when do you expect to see the bottoming in NIM and NII, and what gives you the confidence that we're getting closer to stabilization?
Well, if you know, one thing that's kind of, I think it's kind of interesting. If you look at deposit betas, our total deposit beta this cycle is about 37%, to date. That could creep a little higher. I mean, I think even if the Fed stops, you're going to have a little bit of lag effect that tends to take place. If I look at the last cycle that looked quite a lot like this one, was actually, if you start in mid-2004 through the end of 2006. During that period, you saw the Fed funds rate go from about 1% to 5.25%, really to where we are today.
Mm-hmm.
Started a little higher, but not much. Our deposit Beta through that cycle was 41%. It's actually 4% higher than we are today.
Mm-hmm.
Despite the fact that we had Silicon Valley in the middle of this thing. So, I actually think there's maybe a little more predictability in the entire deposit base than might appear on the surface. You know, what we— Again, what we saw then, we saw a little bit of a lag effect. We saw another over the course of 2007, after the Fed was plateaued at 5.25%. We saw about another 34 basis points in the deposit price cost, total deposit cost increase. So we could see some of that this time, but... In the meantime, you've got assets repricing.
We think that we're kind of getting to a point, especially with weaker loan demand, where we will have a little better control of deposit pricing and where we ought to be able to kind of find equilibrium. You know, where it goes from there, I really think depends on resumption of earning asset growth before it really starts to climb.
And obviously, your earning asset growth, it seems, is going to be slower given, you know, the rundown securities and lack of loan demand. But, you know, the markets are sort of grappling with where interest rates are headed. I know you've studied inflation for many years. Just curious on your outlook for the economy in terms of where you think interest rates are headed. What is the bank planning for in terms of interest rates in 2024? And how does that impact the trajectory of NII, whether it's a higher-for-longer scenario or we start to see some rate cuts happening?
Well, I mean, predicting interest rates is probably a total fool's errand, but, you know, I,
Like Long Grove.
Yeah, like Long Grove. You know, clearly the market is expecting the Fed's gonna, we're gonna see some cuts in the Fed funds rate in 2024, and, we're positioned, I think, about as close to neutrally as we can be for that. All of our assumptions and our models, I mean, we, we've gone through, done a lot of revising of models and assumptions in them, in the wake of Silicon Valley. And so I, you know, I, I'm less confident in any models right now than I... We're just in a different place than we've ever been before. But as best we can tell, you know, we think that we're in pretty neutral shape. I think ultimately there's real risk that term rates rise.
I, I just don't know how you reconcile some of the pressures that we're going to see on the federal, the federal level, you know, debts and deficits, $1 trillion of interest costs coming on in, you know, probably over the next decade on average, according to CBO. It's, you know, I think it's going to be a pressured environment for term rates. I don't know how they come back down short of a lot of Fed intervention, which I don't know, I'm not sure they have the stomach for. I don't think it would be wise. So I, you know, I think we end up - we may end up with something like a more normally shaped yield curve.
Mm.
You know, if you get some, a lower short end and some slope to it, and that wouldn't be all that bad in a lot of respects. I mean, we'd... As much as I, I'd love to see term rates come down, you know, stay down, let some healing take place, but I think that it's probably going to make more sense if we, you know, that we're going to see some slope to the curve. And I tend to think that what we've seen in the last two or three, four weeks has been a little bit of a head fake, personally.
So, you know, a big strength of the company has been the non-interest-bearing deposits. You've had a, you know, over 40%. They reached over 50% as surge deposits entered. And even with, you know, the rapid pace of hikes, you know, they're still at a very healthy level of 35%. And but we've seen it moving around. Like, you show us signs of stability, and then it's come back down. Can you maybe just talk about what your expectations are for, you know, your deposits? What are you seeing amongst your customers? Are they using it rather than borrowing? Are they investing in their business? And what have you done to reach the conclusions that you're getting to?
Well, first of all, you know, it's obviously just natural. It would be expected that there's an inverse correlation between interest rates and demand deposit levels. So as rates have risen, you know, what's happened is what we would expect to happen. It's what we've seen before. I do think that, you know, the 51% you alluded to includes, including the impact of a lot of Fed policy that created a lot of money, and it was landing in bank accounts all over the place. And customers have been spending some of that down. I mean, we're seeing that. That said, I think we're probably getting to a place where that level will probably stabilize if the Fed is finished.
That the larger, you know, the larger balances have already sorted things out, and, you know, what's left is stickier and slower to move. So, I, my belief is we're probably pretty close to seeing that flatten out.
That's good to hear. Maybe just bringing together a couple of different things. You said maybe there's a little bit more upward bias on deposit costs. I think there was some confusion in earnings regarding the latent and emergent and what was being assumed in terms of the deposit costs, right? Can you maybe just clarify for us what is the actual company expectation for deposit costs over the intermediate time frame? And just as a follow-up, given everything that we've been through, you know, you were forced to move to bring deposit costs up in a pretty meaningful way to support liquidity. How easy do you think it's gonna be to bring deposit costs down when we get to the other side of this?
Yeah. Well, I, you know, first of all, maybe some of the confusion was over. You know, we talked about, I think, like, a 50%,
Mm-hmm.
-beta. You know, I actually don't think we get there. The 50% was actually alluding to kind of some assumptions that we're using in models, which are probably a little more conservative than I expect that we'll actually see. Excuse me. The actual behavior, again, you know, I think is going to be... Yeah, you know, if the Fed is done, I think we'll see total deposit costs continue to climb probably in the next two or three quarters, but at a decelerating rate.
Mm-hmm.
And then if the Fed starts to cut, I think you probably got about a lag of about a quarter, and they start to come down. But I don't think there's any reason that I would expect that we wouldn't see betas on the way down that don't pretty well match what we saw on the way up without kind of the step function, SVB impact, if you will.
Mm-hmm.
But if you look at the cumulative, you know, cumulative impact, I think is likely to be, you know, back, back in 2007, 2008, as, as the Fed was bringing rates down, you know, we had about a 37%-38% deposit beta coming down.
Yep.
I would expect we'll see that again.
You alluded earlier to the 3% headcount reduction in the fourth quarter. Expenses have been increasing mid-to-high single digits the past few years as you've increased customer acquisition, you were building out technology, investing in talent. You know, most banks are obviously trying to keep costs closer to flat in this environment, you know, self included, or at least close to flat. But I think you recently highlighted inflation making that harder. Maybe just talk about how you're managing expenses in the current environment, and how do you think about the trade-off between making the necessary investments you need to in the business versus holding off for a better revenue environment?
Well, I mean, the cuts we're trying to make, we're trying to be careful with. I am truly a believer, and it's, I have—I own a lot of shares. I've been in it for a long time. I think I've got a pretty long-term view of the world, and the one thing I've been trying really carefully not to do is to just ax things that are the seed corn for growth a couple of years out. I mean, the technology investments we've been making are a good example of it. You know, they've been... That's something, and you set it in motion, and it becomes really hard to, you know, you don't want to be pulling back and then surging.
I mean, we're trying to get through a big project. I expect, by the way, you know, that I would hope that we're pretty much finished with that by late summer or so of next year. And so, you know, we've been trying to be kind of surgical. We've exited a couple lines of business where returns had just become skinny. We've you know, we gave everybody some targets in terms of headcount reduction, but it's not anything that is, at this point, kind of going to actually get in the way of growing revenue. We're really focused on trying to find producers and people who can build the place.
I think you do that in times that are fat, times that are thin, and you're always trying to do that. But you know, there are things where you cut back, and you say: Okay, we're going to postpone something that's kind of discretionary, and say it's not the right time to do it. That's a process that's always going on. You get a little more serious about it when you have something like SVB. But I think that's. We're all going to be under those kinds of pressures, trying to keep things flat over the next year or two.
You talked about wanting to grow revenues. Obviously, over time, fee income has been a bright spot. It's been a little closer to flat recently. Tell me about the fee income initiatives of the bank. Do you see this driving improved results in 2024, and what are the main areas you're most excited about?
Yeah, I certainly hope so. I mean, You know, what's happened over the 10 years, I hope, helpful to what we're trying to do in our capital markets initiative, which, we've been building out. I mean, and it's not huge, but we have a customer base where we can be doing more, to help with the debt placements and syndications and swaps and a lot of things. And so, we put together a really good team, headquartered out of Los Angeles, and that's over the last two or three years, been a bright spot.
This last year was a little bit flat, but with a little bit of help from the markets, you know, I do think that's one that, over the next five years, is going to see some good growth. Wealth management's another example where we've been building that business, and it's been growing nicely. You know, one of the things that is maybe weirdly helpful is, I mean, we don't have a big consumer business, so, I mean, the CFPB and this administration has been at war with the industry over fees. That's likely to have less impact on us than others. So sometimes what you're not doing is can be helpful. I mean, it'll have some impact, but not proportionately what you'll see from others, I think.
I know that your favorite part of every conference is to provide quarterly updates, so,
Mm-hmm.
We'll take a crack at it and just say, based on some of the comments that you've made, sounds like maybe loan growth a little bit slower, deposit competition easing, or maybe just any changes you've seen within the business over the last 60 days.
Not really. You know, what we said after the end of the third quarter, I think is still relevant today. I don't think it's-- well, it hasn't really changed that much. So I mean, we tend to look out and say: What do we-- we're not believers in saying what's the next quarter hold and trying to-- we'd like to at least get people thinking about what's the next year look like. And, you know, we-- it's gonna be kind of a grind-it-out year. So, nothing really new to add to what we've already said.
You, you talked about the, you know, the big tech transformation, which is 10-year plus going, coming to a conclusion in, in the late summer. I believe the deposit system's the last thing. I guess, once this is done, what, what's next for, you know, the, for the transformation? Is it cloud migration, more digital investment? What, what, what more is there to do?
Well, there's always a backlog and, you know, I suspect you're gonna see the whole industry spending money on what I think of as kind of internal AI use cases where we can create productivity gains with internal modeling. That's when the OCC and our federal regulators are being pretty clear that they're-- I mean, they're really wary of generative AI and sort of customer use cases. But there are a lot of opportunities internally to make people more productive in what they're doing, to help with fraud and cybersecurity and a variety of things. And I expect that that will be one of the places that we're investing. We just hired a new Chief Technology Officer that has some really good background in AI and machine learning, et cetera.
And that is one of the reasons and we're looking to try to do more there. But we're working on a project we call Salesforce Unification, trying to get to one instance of the use of Salesforce CRM tools within the company. And it's just part of an ongoing quest to try and simplify the data environment and make it very consistent across the whole organization. So there are projects like that that we'll be working on.
Maybe shifting to credit. You know, losses for you are still below ten basis points, amongst the best in the industry. Can you maybe just talk about areas of the portfolio you're watching, maybe outside of office? We'll talk about that in a sec. Whether it's multifamily, other parts of C&I. Given your, you know, view of the world, what is a reasonable expectation for losses for Zions over a medium timeframe?
Well, in terms of areas of the portfolio we're, you know, focused on, multifamily is one. I don't expect—I mean, we've seen really good structure in deals, and we've seen it not just with us, we've seen it across the industry. I don't think it's gonna be particularly problematic. I mean, you're seeing some softening in, in some markets. So I think it's gonna, you know, it'll slow new originations, more than anything. But, you know, that's, so that's one we'll be watching. You know, we've been watching anything that's got much leverage in it. You know, in a higher rate environment, that tends to be a, kind of a target-rich environment for trouble. And so far, not seeing anything that's giving us any concern.
So I'm actually pretty sanguine about credit. We've been building our reserves just because we think it's a trickier environment than we've seen in some time, and more question marks around it. But you know, if we see a recession, it'll create some losses, but I don't think. I mean, our goal has been, we said before, and it's basically to be in the top quartile of the industry in terms of charge-offs. I think that's the ultimate measure of credit quality, is all kinds of measures, and we all measure a lot of things, but at the end of the day, over you know, through cycles, what charge-offs look like.
Our goal is to be in kind of the top quartile, and we've tried to maintain a credit culture that delivers that.
So you referenced the allowances increased. I think it's gone up six straight quarters, even though we haven't seen much in terms of losses. Let me just expand what it's driving. Is this mostly just qualitative reserves for, you know, a rainy day, or are you actually expecting losses to pick up?
Well, it's qualitative. It's qualitative in the sense that we have... Yeah, as we've thought about the, we start using Moody's scenarios like a lot of banks do. Fundamentally what we do, I mean, they create several scenarios, and you can build kind of a distribution around them, and they've got a base case. I mean, we've been weighting some of the more severe scenarios because we think that that's actually more indicative of what we could see, given concerns about, I mean, concerns about government shutdown and recession, consumers running out of cash, a variety of things. So yeah, I expect that we'll see higher losses. I think we're pretty well reserved for it today.
I don't think it's, and we're not gonna just build it continually higher without evidence that the world is getting more, more difficult. But we're at 1.3%. That's not, it's not. It's high relative to four basis points, trailing 12 months charge-offs, but relative to what we've seen going into a recession, we think it's about the right place to be.
Got it. Two more questions that I would—I'm hoping to get through. You know, your capital ratios reported just above the peer median, TCE obviously lower. Adjusted CET1 is below peers. How do those impact the way that you manage capital, even though you're not currently subject to the rules, but at some point are likely to be? How does that impact the way that you manage capital over an intermediate time frame?
Yeah, well, we think we've got about four years before we'll cross 100 organically, and that over that period of time, AOCI should pretty well bleed off and be relatively a non-issue for us. With slower loan demand, I expect that we'll continue to build capital through 2024, and I... My hope is that, you know, it puts us in pretty good position to be able to, to start to return some capital, even as we're preparing for, for crossing that threshold.
Just as a follow-up to that, maybe just thinking about the cost of doing that. You know, we talked about, you know, we talked with Comerica earlier this morning about, you know, leapfrogging over the $100 billion. I think I've asked you eight out of nine years. When you finish the tech transformation, where does M&A fit in? And maybe I'll tie it into both that and regulation. Do you foresee M&A fitting into the Zions strategy down the road?
Well, I mean, I absolutely wouldn't count it out. I think—you get through this tech project, I think we'll have a really good platform. It's all about valuations. I don't think the regulatory, you know, the $100 billion threshold is a reason to try to, you know, to leap beyond that. The costs imposed by it, there's some, there's some one-time costs, stress testing, things like that, resolution planning. We've, you know, we've fundamentally built a lot of that and have maintained it back in the,
Mm-hmm.
... in the CCAR days. The larger issue is, you know, is Basel III Endgame and the debt requirement, and those are both, those are both variable costs. So you double in size, it's gonna double the capital, it's gonna double the debt. So I don't think those are economy of scale kinds of issues that would drive it. But there'd be other things. I just good, you know, good fit, infill, creating a, you know, more efficient branch network in terms of larger branch sizes. Things like that would be interesting to me, but not necessarily just trying to be larger for larger sake.
Great. Well, I think we're in overtime, so please join me in thanking Zions.