Good day, ladies and gentlemen, thank you for your patience. You've joined Zions Bancorporation's fourth quarter 2018 earnings results webcast. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session, and instructions will be given at that time. Should you require any additional assistance during the call, please press star then zero on your touchtone telephone. As a reminder, this conference may be recorded. I would now like to turn the call over to your host, Director of Investor Relations, James Abbott. You may begin.
Good evening, thank you, Lateef. We welcome you to this conference call to discuss our 2018 fourth quarter earnings. For our agenda today, Harris Simmons, Chairman and Chief Executive Officer, will provide a brief overview of key strategic and financial objectives. After which, Paul Burdiss, our Chief Financial Officer, will provide additional detail on Zions' financial condition, wrapping up with our financial outlook for the next four quarters. Additional executives with us in the room today include Scott McLean, President and Chief Operating Officer, and Ed Schreiber, Chief Risk Officer. Referencing slide two, 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 the slide deck dealing with forward-looking information, which applies equally to statements made during this call.
A copy of the full earnings release as well as a supplemental slide deck are available at zionsbancorporation.com. The earnings release, the related slide presentation, and this earnings call contain several references to non-GAAP measures, including pre-provision net revenue and the efficiency ratio, which are common industry terms used by investors and financial services analysts. The use of such non-GAAP measures are believed by management to be of substantial interest to the consumers of these financial disclosures and are used prominently throughout these. A full reconciliation of the difference between such measures and GAAP financials is provided within the published documents, participants are encouraged to carefully review this reconciliation. We intend to limit the length of this call to one hour.
During the question and answer session of the call, we ask you to limit your questions to one primary and one related follow-up question to enable other participants to ask questions. With that, I will now turn the time over to Harris Simmons.
Thanks very much, James, and welcome to all of you who have joined us on the call today to discuss our 2018 fourth quarter results and some of the results for the full year 2018. The results for the quarter were strong relative to the year ago results. Slide three is a summary of several key highlights, which we'll address in some detail in subsequent slides. Slide four shows earnings per share on a GAAP basis. They've doubled from the year ago quarter. The year ago fourth quarter had a couple of items that reduced the results substantially, which we've called out on the slide. Additionally, we are of course, subject to a much lower corporate tax rate than the year ago period. Even adjusting for those factors, we were able to accomplish strong double-digit EPS growth.
Turning to slide five, we've delivered on our commitment to produce strong positive operating leverage for the year. With full year non-interest expense up only slightly compared to the prior year, while full year revenue increased 7%. As such, adjusted pre-provision net revenue increased a strong 14% and 13% if adjusted to exclude the charitable contribution in 2017 that we called out in previous earnings reports. For the quarterly results, as shown on this slide, adjusted pre-tax, pre-provision net revenue increased 18% over the same period a year ago, and about 13% if adjusted to exclude the aforementioned charitable contribution. Perhaps most notably, the 13% increase in PPNR produced an 18% increase on a per share basis, due primarily to $670 million worth of common stock repurchases completed during the year. We're very pleased with the 18% increase in per share PPNR for the year.
On slide six, you'll see the strong credit trends depicted on the chart on the right, with classified loans declining 38% from the year ago period and 11% from the prior quarter. Improvement in oil and gas loans was a major reason for the improvement. For the fourth quarter, we experienced net credit recoveries of $8 million or an annualized seven basis points of loans. We realized net loan recoveries of four basis points for the full year. Credit recoveries equaled $21 million for the quarter and $85 million for the year. Recoveries may remain a beneficial factor over the next few quarters, although we expect the oil and gas credit recovery cycle to subside. Non-performing assets plus loans 90 days past due declined 42% from the year ago period and equaled only 57 basis points. Our allowance for credit loss actually increased one basis point from the prior quarter.
As noted in the release, the quantitative factors improved from the prior quarter. Due to a variety of broad macroeconomic and political factors, we increased the qualitative portion of the allowance. We're not seeing any substantive indicators of a turn in the credit cycle, although we are exercising caution in our lending activities generally, so that we'll be well prepared for any downturn that might materialize. We currently expect a low overall rate of gross and net charge-offs in 2019 and relatively stable problem loan ratios, assuming economic conditions similar to what we experienced in recent months. One broad industry topic that has been generating a lot of recent attention with investors is leveraged lending. One of the issues in discussing this that you have to focus on is the comparability of results across companies, as there are varying definitions of such loans.
Slide seven shows the result of a survey done by Moody's that included 38 regional banks, including Zions. Moody's asked each bank to provide a dollar amount of loans where the subject company's total debt exceeded four times the company's earnings before interest, taxes, and depreciation, or EBITDA. At the time the survey was conducted, June 30th data was provided by the participants. It was measured as a percent of Moody's definition of tangible common equity, which isn't quite the same as the way we present our tangible common equity. Regardless, the results are comparable to the other 37 banks. You can see that Zions exposure is more than one-third less than the peer average and about one-fifth less than the peer median. This isn't a line of business for us.
Some of the loans in that bucket were not originated as leveraged, but are there today because of the recent recession in the oil and gas industry, which reduced cash flows for those borrowers. As cash flows for the energy industry improve, our exposure to loans with debt to EBITDA of more than four times should decline from current levels. In recent years, we've been talking frequently about the strategic importance of our long-term technology investments, all during a time when we have been keeping our expenses relatively flat. On slide eight, you can see the key investments we are making in our core operating systems, customer-facing digital technologies, and how they will improve the experience for our largest customer segments.
To highlight a few, I'd begin at the bottom of the slide and note that our future core programs replace our three loan systems and deposit system, represents a generational investment, and it is progressing very nicely. By the first half of this year, all of our loans will have been converted to our new modern platform. Moving to the top half of the slide, let me highlight a number of significant new customer-facing digital technologies that are in various stages of rollout. Treasury Internet Banking, or TIB 2.0, as we call it, is the primary online communication tool that 8,000 of our largest commercial customers utilize. We believe we are top of the industry in providing treasury management products for our clients, and this upgrade even further enhances our digital capabilities that touch customers with approximately $10 billion of our $24 billion in non-interest-bearing deposits.
Next, the rollout for our digital business and mortgage loan application software will represent a significant improvement to the customer experience and how we process these types of loans on an end-to-end basis. In the case of mortgage, the digital application will give us the ability to pull down our customers' income tax forms along with bank statements. These are two of the biggest customer pain points today. Finally, in early 2020, we'll replace our online mobile banking systems, which touch over 600,000 retail customers and 125,000 small business customers. This system is a workhorse for us, and we believe our new offering will position us well relative to our major competitors and close a number of gaps that exist today. Each of these technology investments are foundational and focused directly on our most important customer segments, and the benefit should be long-lasting.
Slide nine is a list of our key objectives for 2019 and 2020 and our commitment to shareholders. We believe we can continue to deliver strong positive operating leverage as we deploy technology and continue to implement many of the thousands of ideas we've collected from employees on how to better operate in a simple, easy, and fast manner. We expect that such positive operating leverage will allow the pre-provision net revenue to grow at a rate in the high single digits without the help from additional rate hikes. We're firmly committed to demonstrating superior credit quality relative to our peers, which has been the bank's primary source of earnings volatility in the past.
Regarding return of capital to shareholders, we have increased the payout ratio, which is defined as payouts to common shareholders as a percentage of earnings applicable to common shareholders, from approximately 20% of earnings a few short years ago to more than 140% in the fourth quarter of 2018. We view an increase in balance sheet leverage as appropriate, particularly given the reduction of the risk profile of the company. Since 2009, which was probably the year of peak stress for most banks and certainly for Zions, the total assets of the company increased 34%, while the risk-weighted assets increased only 4%. Our changing asset mix was the primary contributor. We replaced CDOs with government agency mortgage-backed securities. We replaced land development loans with municipal loans and residential mortgages. Outside of asset concentrations, we have rooted out risk in many different areas within operational risk.
It's this reduction of risk that allows us to reduce our capital from the current level. The decision on the magnitude, timing, and form of capital return is a board-level decision, and we'll update you as appropriate. With that overview, I'm going to turn the time over to Paul Burdiss to review our financials in a little additional detail. Paul?
Thank you, Harris, and good evening, everyone. As Harris said, this is a good quarter in our opinion and a solid year on many fronts. I'll begin on slide 10. This highlights two key profitability metrics, return on assets and return on tangible common equity. We are encouraged to report the return on assets at about 1.3%, even after adjusting for infrequent items, and the return on tangible common equity to again exceed 14%. We expect positive operating leverage to combine with solid credit performance and continued strong capital returns to result in further expansion of balance sheet returns. On slide 11, for the fourth quarter of 2018, Zions' net interest income continued to demonstrate solid growth relative to the prior period of $50 million to $576 million, or 10%.
In some of the prior quarters, we have called out interest recoveries that were greater than $1 million per loan, but we did not have any such recoveries in either the year-ago quarter or the fourth quarter of 2018. With respect to the revenue components, I'll start with the balance sheet volume and move to rate in just a moment. Slide 12 shows our average loan growth of 4.2% relative to the year-ago period. Although not listed on the slide, the period end growth in the fourth quarter relative to the third quarter was an annualized 8%. Average deposits increased 3.6% from the year-ago period and increased an annualized 5% from the prior quarter. Average non-interest-bearing demand deposits increased 1% from the year-ago period, and 5% from the prior quarter, annualized.
Thus far, we've been able to achieve this growth of deposit balances with a relatively modest increase in deposit cost. Our cumulative increase in the cost of total deposits since the third quarter of 2015, which was immediately preceding the first rate hike by the Federal Reserve, has been only 25 basis points, or a total deposit repricing beta of about 12% over that period. This speaks to the quality of our deposit franchise. We have a favorable mix of relationship-based operational deposits. As we look at the stratification of deposits by size, for example, deposit customers with less than $5,000 with us, or our customers with more than $50 million with us, we see very low cumulative deposit betas in this rising rate environment for customers with balances of less than $5 million, and that represents about three-quarters of our total deposit base.
Examining loan growth a bit closer, slide 13 depicts year-over-year period end balance growth by portfolio type, with the size of the circles representing the relative size of the portfolios. For most categories, we experience solid and consistent growth. There are three areas we've experienced slight attrition. In the commercial real estate space, loan growth was adversely impacted by slight attrition in the term CRE and national real estate portfolios of about $235 million over the prior year. We have also continued to experience attrition of some of our larger loans, some of which was intentional, to reduce loans that were not meeting our profitability requirements and reallocate that capital elsewhere, and some of which has been due to the incremental competitive pressure on larger commercial loans, which appears to be coming from debt funds, debt capital markets, and covenant-light structures and asset-based lending, perhaps from other banks.
Pressures that we noted in the last quarter have continued. We experienced relatively consistent growth trends in our one to four family and home equity loans, which have been growing in the mid to high single digits for quite some time, and we are pleased with the continued growth of owner-occupied loans, which have been growing in the mid to high single digits year-over-year for the past six quarters. As a reminder, owner-occupied commercial loans are generally small business loans underwritten based upon the cash flows of the borrower and include real estate in the collateral package. Oil and gas loans have increased 16% over the prior year, primarily from a relatively strong increase in exploration and production loans. Importantly, our oilfield services loans are now less than 1% of total loans and are down about $500 million from the 2014 year-end figure.
Municipal loan growth has also continued to be strong during the past year. As noted on previous calls, we've hired staff to help us grow in this area, which is focused on smaller municipalities and essential services of those cities. We've maintained strong credit quality standards and feel very good about the risk and return profile of this portfolio. We are optimistic in the near term about the growth of loans based upon the relatively strong economic backdrop, improvement in small business and owner-occupied loan growth, and a review of lender sentiment. As noted earlier, there are competitive forces, generally outside of the banking industry, that cause us to keep our outlook at slightly to moderately increasing. Our organization is aligned in our view of the trade-off between loan growth and incremental risk.
We would rather maintain our underwriting standards and accept less loan growth. We believe investors will be rewarded in the longer term for this discipline. Slide 14 breaks down key rate and cost components of our net interest margin. Top line is loan yield, which increased to 4.79%, up eight basis points from the prior quarter. Recall in the prior quarter, about two basis points of loan yield were related to the previously mentioned interest recoveries. We are looking at our loan beta or our change in loan yield relative to change in the Federal funds rate, and we calculate a repricing beta of about 50%, which is consistent with a portfolio that has about half of its loans indexed to either prime or short-term LIBOR, and we show this in the appendix on slide 24.
Relative to the prior quarter, the yield on securities increased 18 basis points to 2.46%. About eight basis points of the linked quarter increase is attributable to reduced premium amortization relative to the prior quarter. The remainder is primarily due to older securities with lower yields running off and using that cash flow to buy new securities at higher yields. The shorter duration of the portfolio is helpful. Recall, we've built a portfolio that has almost no net convexity in our models. Therefore, we believe duration extension risk is limited. Cash flows, therefore, remain generally stable as rates rise, allowing us to reinvest cash flows at the new money yield of about 3.25% in the current environment, which compares favorably to the 2.5% yield of the overall portfolio. As a reminder, premium amortization is highly dependent upon prepayments and therefore difficult to accurately forecast.
Assuming stability there, the yield of the securities portfolio should move higher at a moderate pace over the near term, all other things equal. The cost of total deposits and borrowed funds increased nine basis points in the quarter to 0.54%, resulting in a funding beta of about 30% for the year-over-year and linked quarter figures. As a reminder, in this case, beta refers to the change in the deposit cost and borrowings relative to the change in the target Fed funds rate. These elements combine to result in a net interest margin of 3.67% for the quarter, which increased four basis points from the prior quarter and 22 basis points from the year ago period.
The net interest margin beta, or the rate of change in the net interest margin relative to changes in the Fed funds target rate, was 22% over the prior year. One of the more substantial drivers of this margin expansion is the increasing value of our non-interest-bearing deposits in the higher rate environment. Because of the nature of most of our deposits being operating accounts for businesses and households, we expect our non-interest-bearing deposits base to remain a competitive advantage. As we have noted in prior public appearances, if the economy remains strong and industry-wide loan growth accelerates, perhaps then we might expect deposit competition to intensify somewhat. If that becomes the case, our net interest margin beta may be somewhat less sensitive to rate increases when compared to prior periods.
Additionally, we've begun to discuss a moderation of our asset sensitive position as the rising rate cycle may be decelerating. As with other balance sheet composition changes, such as capital distributions and moving cash into securities, we are unlikely to move quickly and aggressively, but rather make any such changes at a measured pace. Finally, we expect that if the Federal Reserve remains on hold with interest rates, the net interest margin should be relatively stable over the near term, driven by factors already highlighted in my comments. Next, a brief review of non-interest income on slide 15. Customer-related fees increased 1% over the prior year to $128 million. The primary sources of income that changed are listed on this page. For the full year, customer-related fee income increased by more than 3% to $501 million.
We continue to work hard to accelerate fee income growth, although fees from treasury management are influenced to a degree by deposits and by market rates for earnings credits applied to those balances, which in a rising rate environment can create a slight headwind in our fee income trend. Similarly, the fee income realized from mortgage banking activity tends to be countercyclical, slowing and possibly decreasing when the economy is strengthening due to the effect of higher interest rates on refinancing activity. Non-interest expense on slide 16 increased to $419 million from $417 million in the year ago quarter. Adjusted non-interest expense, which adjusts for items such as severance, provision for unfunded lending commitments, and other similar items, was also very stable at $418 million versus $415 million in the year ago period.
If we make one further adjustment to the year ago period, that is the larger than usual charitable contribution of $12 million, the core adjusted non-interest expense increased about 3.7%, which is moderately higher than the outlook we provided to investors a year ago of low single digit. I would note that credit quality performance and revenue growth were stronger than originally modeled, and most of that outperformance has been passed or is being passed on to our shareholders. As discussed in various public appearances during the quarter, we expect to and did experience a significant reduction in FDIC insurance costs from the prior quarter and the year ago period. Recall that in the prior quarter, we had a nearly $4 million FDIC insurance expense cumulative adjustment, which was related to the consolidation of our bank charters.
Since 2016, we were subject to the large bank surcharge that was designed to drive the Deposit Insurance Fund to a reserve ratio of 1.35%. The large bank FDIC surcharge was eliminated in the fourth quarter because the Deposit Insurance Fund reserve ratio objective was met, this served to reduce our FDIC insurance expense as compared to the prior quarter by about $6 million. Turning to slide 17, the efficiency ratio was 57.8% compared to the year ago period of 61.6%. The efficiency ratio calculations have some seasonality to them in that there are more days of interest income in the second half of the year.
when compared to the first. Of course, the seasonal expense increase in the first quarter of each year related to payroll tax and stock-based compensation, among other items. We reiterate our commitment to achieve an efficiency ratio of below 60% for the full year of 2019, excluding the possible benefits of rate increases. Finally, on slide 18, this depicts our financial outlook for the next 12 months relative to the fourth quarter of 2018. There is no significant change to our outlook from that which was reported throughout the fourth quarter of 2018, as you can see on this slide. This concludes our prepared remarks. Lateef, would you please open the line for questions? Thank you.
Yes, sir. Ladies and gentlemen, if you have a question at this time, please press star then one on your touch-tone telephone. Again, that's star one on your touch-tone telephone to ask a question. If your question has been answered or you wish to remove yourself from the question queue, please press the pound key. To prevent any background noise, we ask that you please place your line on mute once your question has been stated. Our first question comes from the line of David Rochester of Deutsche Bank. Your line is open.
Hey, good afternoon, guys.
Hey, Dave.
You had a nice move in that core NIM this quarter. Was just wondering, sorry if I missed this, but if you're thinking about an up three to four basis point NIM given hikes as your base case going forward, and especially given the December hike we just had. Then on your NII guide, was just wondering if you're assuming that the current flat interest rate curve persists, and if we don't get any additional rate hikes, was curious about your base case for deposit costs, assuming that stable NIM guide that you just gave for that scenario.
Dave, I'll start out and ask my partners here to weigh in. With respect to the, I think kind of what you referred to as the NIM beta, that is any NIM expansion related to the change in underlying rates, that's approximately right. I did say in my prepared remarks that we were expecting a few basis points. I think I quoted that 22% sort of NIM beta related to the change in underlying the Fed funds target. That has been our experience over the last couple of quarters. Impossible to predict it with a lot of precision, as you know. If loan pricing and composition and deposit pricing and composition behaves, we would expect something that looks kind of like that. The second part of your question was related to deposit costs.
Our base case is that we would expect deposit costs to drift marginally upward over the course of the next several quarters, sort of reflecting a catch-up on the change in rates. As I said, we believe we have a very strong deposit rate base as it is very relationship driven and largely operational in nature. So the composition of our deposit base, we would not expect to change a lot. Likewise, we expect the rate on deposits to remain well-behaved.
Perfect. Thanks. Just one, just switching to loans real quick. Just a small one. In your table, the heat map in the back it looked like it was a great loan growth quarter. The drivers were varied a little bit in terms of your markets. Was just curious, what was the driver, the runoff in C&I at Amegy and the strength in California? It looked like California was really strong for you guys. Maybe if you can just give an overarching comment on that too, that would be great.
Sure, Dave. This is Scott McLean. For the quarter, the linked quarter, the bottom half of that slide 22, Amegy did have a soft quarter. It really is related to the softness that the top half of that page indicates. They have had a book, about $150 million book of lower profit business that they were allowing to run down. There was one client that we actually moved from C&I to energy largely because that customer's revenues related to energy had actually increased. These are the kind of moves we make as we watch our commercial clients. Other than that, they are seeing all the same pressure on the high end of the market that you hear from other banks and that we have reported before.
I would note the top half of the page, and it really is borne out in that bottom half too, that if you look at the top half year-over-year, it really is good balanced growth between C&I owner-occupied. You see kind of $600 million there.
The muni lending of $400 million, the home related lending of over almost $700 million. Just good solid balance, we continue to be pleased with that. The other thing that isn't showing up quite as much this quarter as it did in the third quarter and the second quarter, our four smaller affiliates Arizona, Nevada, Colorado, and Washington, they make up about 25% of the company. They have actually been really producing solid loan growth, probably 35%-40% of the loan growth of the company up until this quarter when the larger banks kicked in more in line with what the larger banks have done historically.
Any specific drivers of the C&I growth in California just for this quarter in that bottom chart?
No.
There were a couple of larger deals, but nothing that really stands out.
Okay.
I think it also was helped by just slower paydowns
Okay.
That was it all.
Great. Thanks, guys.
Thank you.
Thank you. Our next question comes from the line of Kenneth Zerbe of Morgan Stanley. Your line is open.
Great. Thanks. Good evening.
Ken.
Just had a question. On slide 18, the loan growth or loan balance commentary that you have. It looks like you explicitly called out competition from non-bank lenders. I know you addressed a little bit in your comments, but this is the first time you've actually written that in your outlook. Has the competition from the non-banks gotten worse or how is that changing? Thanks.
This is James, Ken. I would describe it as this is fairly consistent with what we saw or at least what the lenders report to us that they were seeing in the prior quarter. We're just reiterating the concept here. I'm aware that some other banks have mentioned that in the month of December, it wasn't as intense for them. Our folks have reported that it's been fairly similar throughout the quarter. Perhaps some difference between geographies, I suppose, us versus some other banks, I suppose. It's a consistent pressure.
Got you. Okay. Understood. Just maybe a question for Harris. In terms of capital return, I know you said it is a board decision in terms of when you announce that. I guess, first of all, when does the board meet that when we might hear some sort of outcome of that around capital return? Also, B, just given where your stock is, given how much the whole market sold off over the last several months, has your thinking about capital return changed? Could you be more aggressive or would you ask for more aggressive share buybacks given what's happened with your stock price? Thanks.
Well, first, they meet a week from Friday. You can put that on your calendar.
Will do.
I think we may look to be incrementally more aggressive. Obviously, again, a conversation we'll have with the board and as well as with regulators. That's something we take seriously as well. We think there's room to do still a fair amount of capital distribution, and we're certainly cognizant of where the market is today relative to where it's been. We'll take that into account for sure.
Okay. All right. Thank you.
Thank you.
Thank you. Our next question comes from the line of Jennifer Demba of SunTrust. Your line is open.
Thank you. Good afternoon. Just curious about the process improvements that Zions has made in the last several quarters, and wondering where we are kind of in the innings of that process. How many more internal processes do you think there are that can be improved, and if you could give us examples of what we're looking at.
Sure. Jennifer, this is Scott McLean. How are you?
Good, thanks.
Yeah, we probably all have a different gauge on this. I would say we're in the early innings. Probably somewhere in the third inning. We've been at this for three years. There is just a significant number of small to medium-sized opportunities that is providing a really nice source of expense reduction. It's not any one big initiative, but it's a collection of smaller ones that are allowing us to reduce expense half a million dollars, $1 million at a whack, and sometimes more than that. The way I would characterize them is they're largely related to adopting common practices and where we may have had six different practices in a certain area. When it comes to process or technology, we're adopting one practice across the company. All our affiliates have agreed to that. They feel just fine about it. It's adopting common practices.
Another area or theme would be around automation and numerous examples of just taking simple activities and automating them where it can take two, three days out of a process. I'm happy to give you examples. Could do that offline for over an hour. Those would be probably the two most important common themes. The third one would just be on our technology initiatives, like the ones that Harris highlighted. We're not customizing our new technologies. That will create a savings ultimately longer term.
Great. Thanks, Scott.
Thank you. Our next question comes from Ken Usdin of Jefferies. Your line is open.
Thanks. Good afternoon. First question, just on the tech initiatives page that you showed earlier in the deck. It looks like a lot of those things are finally getting to a point where in 2019, we should start to get that full implementation. I was wondering if you can update us on how much that double spend was costing still in 2018, and at what point do we start to see that turn into net savings? I know that's been a long-tail discussion, but it seems like with this slide that we should be getting closer to that. I wonder if you can help us understand the trajectory. Thanks.
The first thing I'd say is I just wouldn't look for tech spending to decrease. We're spending a lot on this core system replacement. We're about halfway through the total exercise. We'll have about half the balance sheet there, we expect by the end of February, actually. We'll be making decisions about that here in the next couple of weeks to go live with the second of three releases of this core systems platform over Presidents' Day weekend. Once we do that, we'll have all the loans on. We then have the deposit piece to proceed, too, and that's the most complicated of them and probably represents about half of the total effort. The spending, some of this has been capitalized as we've gone. Some of that capitalized spending is now being amortized because the consumer loan portion has now been in service for the last year.
We'll have the commercial loan piece in service, I would expect, by the end of this quarter. We'll start amortizing that, then we have the spend on the deposit system, roughly half of that gets expensed and about half of it, roughly, gets capitalized. The need to continue to spend on technology is I just don't see an end to it. Every time I thought that maybe I would, then there's the next new thing. I do think that in the grand scheme of things, it's one of the things that is producing the ability to keep operating costs reasonably flat. The total spend on technology has continued to increase, even as the spend in other areas has been diminished. I think that that can run for a ways longer.
That is one of the things that gives us a fair amount of optimism that we will be able to continue to see some reasonable operating leverage. If the economy holds up and short of a recession, I think that is going to work pretty well, but it will not be for a lack of technology spending.
This is Scott. I would just add to that many of the systems we are replacing or enhancing are fully depreciated, and the expense burden current year P&L cost is really quite nominal. Generally, on almost all these technology investments, you are increasing your cost initially. You may be able to have a savings elsewhere, such as in FTE, but just the pure technology built-in expense goes up for a three to five-year period, depending on how long you are amortizing it. The other thing I would say is that as we look at our total technology spend on a P&L basis, probably 60%-70% of it is offensive. It is not just keep the lights on. That number was just the opposite, probably five, six years ago.
The good news about this spend is that it is building out all the systems that Harris described, many of the systems Harris described, and it is largely an offensive investment.
Understood, Scott. If I can just follow up on a point Harris made. Harris, your point about looking forward, I am looking at the 2019 and 2020 objectives, and to your point about presuming the economy holds up and a lot of things go the continued way they have gone, that target of trying to get to a high single digit pre-provision net revenue growth, do you think you can maintain that magnitude given the point you made about the hope for continued decent positive operating leverage?
I think over the next year or two, that would be our objective. Obviously, at some point, that kind of compounding catches up with you. I think it's instructive to look at where we've brought the efficiency ratio over the last three years from up in the 73%, 74% down to a number that's now really competitive, pretty competitive with the peer group. I guess the point is we don't think we've finished yet, and that will help to drive operating leverage here for the next year or two.
Okay. Thank you.
Thank you. Our next question comes from the line of Steven Alexopoulos of J.P. Morgan. Your question, please.
Hi, everybody.
Hey.
I guess to start, to follow up on the conversation of the need to reinvest in technology, when we look at the low single digit expense guidance for 2019, what's the most realistic range that we should be thinking about for 2019?
I'm sorry, you mean you want me to?
Expense growth range.
Yeah. We are using that language deliberately because we're trying not to be overly prescriptive around that because we need some flexibility to take advantage of opportunities as they may come up. Our definition of low single digits, I think, is consistent with what it has been in the past.
Okay. This year, 2018, if we adjust out the charitable contribution, I think, Paul, you said you were 3.7%.
Yeah.
Could we be at that range again in 2019?
Sorry. What I said was that was a little bit over our targeted range of low single digits to kind of put some guardrails around that.
Okay. Right. I guess I'm trying to understand, given there's a lot of talk on reinvestment in technology, if we should be bracing for another 3% or so year on expense growth or.
It's really important to note, though, that we've also got, as Scott said, a lot of opportunities to continue to simplify the organization. We are working really hard, as Harris said, to take the savings that we are creating out of operational efficiencies and invest it in technology to ensure that, not only are we providing table stakes for our customers, but really starting to be a little more offensive with respect to the products and services that we can offer.
I'd tell you, too, that part of our plan for this coming year is to invest more in people to build a stronger pipeline of bankers for the future in training, et cetera. We just think that's critical, and we'll probably be spending more there even as we're finding ways to fund that. I think we're quite optimistic that we can do that while still keeping total non-interest expense kind of in this low single digit kind of range. I define low single digit as being where the guardrails on that are, in my mind, are going to depend in part on what revenue growth is looking like, too. One of the things that added to this 3.7% growth is just incentive compensation. Because if you look at PPNR, forget about the effects of tax reform.
PPNR was up about 13% on a real apples to apples basis. Incentive compensation's going to rise as that happens, and that's one of the real drivers this year of that 3.7%.
Okay.
Credit performance.
That's helpful
has been really strong, as I noted in my comments.
Yep.
Just separately, if we look at non-interest bearing deposits, your balances have been far more resilient than just about every peer out there. Are you guys expecting to see a migration out of non-interest bearing this year, or do you think those balances can hold in there? Thanks.
Well, I will say that our models would indicate, and as we described in the past when we describe our interest sensitivity, our models assume some level of migration out of non-interest bearing deposits and into other interest-bearing funds. As you said, our deposits have been very resilient, and probably, I would say more resilient than our models would have indicated. When we really peel that back and do the analysis behind it, we think the key driver is the relationship nature of the deposits and the proportion of operating deposits that we have. At a very granular level by customer, we can sort of discern what average balance is, highs and lows, and really measure that against operating needs. The fact is that we've got a very high proportion of those demand deposits are operating deposits.
Because of the relationship nature, because of the operating nature of the deposits, they are just proving to be a little more sticky than even we had expected.
It's also related to our loan growth. Where you see our loans growing is in C&I, owner-occupied, municipal, home equity, and one to four family. Those are all really deposit-rich kind of customers. If our growth was really heavy in CRE, you just wouldn't see the same kind of DDA balance growth. One of the nice things is that our DDA balances, on average, are really growing pretty consistently across the company, depending on what time periods you look at. There's certainly been more pressure in Texas, which you would expect. It's a larger client market. There's been certainly pressure in Utah related to the credit unions. Really good solid growth in DDA non-interest bearing across the company.
I'm going to make one more comment just because I'm so excited about the value of our deposit base. I talk about it a lot, those of you who know me. Another really important point is that, as I said in my prepared remarks, when we look at a stratification of our deposits by deposit size, that is by sort of customer size, deposit size, we see a real difference in behavior in terms of resiliency of the volume with respect to the required deposit repricing betas, a real difference based on the stratification and the size of the depositors. What we are observing is our very largest depositors, of which on a relative basis we probably have fewer, are much more sensitive to rate, and therefore deposit migration is more prevalent there.
As I said in my prepared remarks, 75% of our depositors, approximately, are under $5 million. That's where we're seeing a lot of stickiness.
Mm-hmm. Great. That's really good color. Thanks for taking my questions.
Yeah. Thank you.
Thank you.
Our next question comes from Gary Tenner of D.A. Davidson. Your line is open.
Thanks. Good afternoon.
Hey, Gary?
Just a couple of quick questions. First, and I'm sorry if I missed this, did you mention along the way what your yields were on new loan production for the fourth quarter?
We haven't mentioned it, but it's probably near 5.25, 5.20 GAAP yield, somewhere thereabouts.
Paul, as you were going through your remarks, you mentioned or you highlighted the FDIC insurance. Is the $6 million a good run rate, or was there any adjustment this quarter that reduced that below what the kind of forward run rate would look like?
What I tried to say, there was approximately six, $5 million-$6 million reduction in FDIC insurance, specifically related to the elimination of the Deposit Insurance Fund surcharge. I would expect that to continue.
Said differently, Gary, I think that the number that you're seeing in the income statement there this quarter is a pretty good run rate.
All right, perfect. Thank you.
Thank you.
Thank you. Our next question comes from the line of David Long of Raymond James. Your line is open.
Good afternoon, guys.
David.
Going back to expenses here really quick. If your financial outlook on the revenue side does not materialize here in 2019 at the point where revenue is possibly down, do you have levers to pull on the expense side to still put up positive operating leverage for the year?
Well, historically, we have. Harris or Scott, please jump in. Historically, where revenues expenses were not aligned, we have absolutely been able to adjust our expenses. The biggest lever we have there is incentive compensation, which is a lever that we have absolutely used over the course of the last couple of years.
Yep.
Okay, got it. Separately, we're starting to see banks do some deposit pricing strategies in different regions. Are there any regions where your deposit base may not be as strong or regions where you think there are opportunities to gain share by doing some incentive pricing?
Well, we price locally. Each of the affiliate banks manages their deposit pricing. We obviously give them internal credit, and they kind of weigh the opportunity versus what they can earn internally. Probably the largest opportunity, frankly, is with internet money market accounts and things that we can do on the margin, including just broker deposits. There are limits to how much of that we'd want to do. I think fundamentally, we want to make sure that we are protecting the deposit base we have, making sure that it's continuing to grow and growing for the right reasons. On the edges of that, there are some things we could do, but I don't see us doing kind of blitz campaigns in any of the markets where we have branches.
I'll add, if I could, that rate is not the primary value proposition that we're offering to our customers. It's really about kind of advice and skill. Rate will tend to attract hotter money that provides funding, but not liquidity, as you know. This is something that we think about very carefully.
Got it. Thanks, guys. Appreciate the call.
Thank you.
Thank you. Our next question comes from Christopher Spahr of Wells Fargo. Your line is open.
Thank you for taking my call. The comments on the repurchase authorization, the board meets a week from Friday. When you say more aggressive, like more of the same or perhaps more than the $250 million that we saw in the fourth quarter?
Yeah I'd say stay tuned. More of the same would only be more aggressive relative to doing less, I guess. I think I'd really want to wait until the board has something to say. I don't want to front run them too much here.
Then going back to Scott talking about some of the offensive benefits of the initiative that you're doing on slide eight. Can you give us some examples of what those offensive measures are? I think most of the examples you gave are more on the expense side. What I'm getting at is that fee growth still is kind of lagging some of your larger peers, and I'm just wondering what areas we can expect or might see a pickup in growth.
Sure.
Thank you.
Yeah. If you look at slide eight, really the top five sort of horizontal panels are all offensive. I'll skip to sort of the digital business loan application and the digital mortgage loan application. Again, this is an online way for a client to start a loan application. In the case of a digital business loan application, start it at home, work on it in the branch with a banker, complete it in their office. Send it in. We've automated a way to take the data and pull it into our loan origination system, and then make a decision very quickly. All of this happens by paper today, and there's not an electronic version of it. This digital mortgage loan application, again, as Harris noted, to be able to pull down a customer's tax forms and their bank statements with other banks, it is a game changer for us.
We're not going to change the dynamics of the residential mortgage lending business, we don't have to. We originated about $2.5 billion this year. We'd like to think of that as a $4 billion-$5 billion origination business for us. This product particularly allows us to originate conventional mortgages, which has not been a large part of what we've done historically. It allows us to create a much more viable mortgage product in our branches. We're very excited about it. Those two particularly are, all of these, are rich with authentic client-building opportunities.
Thank you. Our next question comes from Kevin Barker of Piper Jaffray. Your line is open.
Good morning. I mean good afternoon. Sorry, I'm so used to that. In regards to the securities portfolio, it seems like it repriced quite a bit this quarter, and you cited some of the premium amortization. Was there any shift in duration of the portfolio and your expected turnover in that portfolio?
No. A lot of it was related to, as I noted in my prepared comments, kind of a change in the premium amortization due to a change in prepayments. The products that we're investing in have remained relatively consistent. Duration of the portfolio is consistent. Extension risk is limited in our models, as I noted. Importantly, for example, we don't have any 30-year MBS in the portfolio. All of those philosophical items around the portfolio haven't changed.
Okay. Then in regards to the follow-up on some of the comments around oil loan pickup, we saw a little bit of pickup this quarter compared to what you've seen in previous quarters. We saw some of your competitors also cite a pickup in oil lending as well. Is it primarily due to increasing demand or a slowdown in the runoff that you've seen previously?
This is Scott again. The growth that we've seen year-over-year in energy, really the majority of it is upstream reserve-based lending and midstream. Both of which we had very low loss content in. Our energy services portfolio saw a slight uptick, but it wasn't anything to really speak of. As you know, our energy services portfolio now represents about low 20s, 22%, 23% of our total portfolio. Going into the downturn at the end of 2014, it was about 40%.
Scott, if I can just clarify, that's total oil and gas loans, not total loans. Is that 20% of total oil and gas loans?
That's right. Yes. Thank you, James. We've changed the mix of the portfolio. The portfolio also sits today in outstandings at about $2.3 billion, down from $3.1 billion at the end of 2014. We've contracted by about a third and repositioned the portfolio also. The growth, again, we're seeing is primarily reserve-based and midstream, again, which are really solid markets for us.
Okay. Thank you very much.
Thank you.
Thank you. At this time, I'd like to turn the call back over to Mr. Abbott for any closing remarks. Sir?
Thank you, Lateef, and we thank all of you for joining the call today. If you have follow-up questions, please contact me at james.abbott@zionsbancorporation.com, and I'll be available throughout the evening to return your request. Thank you and good evening.
Ladies and gentlemen, that does conclude your program. Thank you for your participation, and have a wonderful day.