Gentlemen, thank you for your patience. You've joined Zions Bancorporation's third 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 0 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. Sir, you may begin.
Thank you, Lateef, good evening everyone on the call. We welcome you to this conference call to discuss our 2018 third 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 today include Scott McLean, President and Chief Operating Officer, Edward Schreiber, Chief Risk Officer, and Michael Morris, our Chief Credit 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. We will be referring to the slides during this call. This earnings release, the related slide presentation, and this earnings call contains 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 the disclosures. 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 section 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 turn the time now over to Harris Simmons. Harris?
Thank you very much, James. We welcome all of you to our call today to discuss our 2018 third quarter results. The results of the quarter were strong relative to the year ago results. Slide three is a summary of several key highlights. At a high level, perhaps most importantly, we're pleased with the strongly positive operating leverage, with non-interest expense nearly flat relative to the prior year, while net revenues have increased in the mid-single digit range. Much of what we are doing is designed to push the tremendous operating leverage that we've experienced during the past three and a half years into future years. Loan growth was relatively healthy in a quarter that can often have a slowness due to seasonal reasons. We're encouraged with our deposit costs exhibiting a relatively low increase compared to benchmark rates.
We're encouraged with further growth in average non-interest bearing deposits, something that's not easily accomplished when interest rates are rising. Our credit quality profile continues to improve at a rapid rate. Remarkably, the trailing 12-month net charge-off ratio was only 100th of a percentage point, or one basis point. Finally, relative to the prior quarter, we increased the dollars of capital returned to shareholders. While we intend to further reduce the capital ratios to better reflect the risk profile of the company, we still have one of the very strongest capital levels within the regional bank space with a Common Equity Tier 1 ratio of 12.1%. Before we dig into the numbers, within the theme of simplification and streamlining, I'd also like to note that we completed our merger of the holding company with and into the bank, reducing organizational complexity and eliminating duplicative regulatory oversight.
On slide four, you can see the improvement of earnings rising to a $1.04 per share from $0.72 per share in the year ago period. Although we don't provide a so-called core EPS figure, we do highlight some items that affected the earnings per share that we view as episodic or not sustainable in the long run, which are listed on the slide. Graphically, the GAAP result are the darker blue bars, while the adjusted result is shown in the light blue bars. Much of the variance is due to continued improvement in credit quality, including interest recoveries that affect the net interest margin, as well as negative provisions for credit losses. We've benefited particularly from the relatively rapid improvement in the quality of loans to the oil and gas sector.
We still have some expected benefit left from that source. We're nearing the end of that favorable impact. Earnings per share for the third quarter of 2018 continued the trend of strong growth. By my calculations, if one eliminates the effect of interest recoveries, negative provisions for loan losses, and if you hold the tax rate constant with the year ago period, our EPS growth was in the high teens relative to the third quarter last year. Slide number five highlights two key profitability metrics, return on assets and return on tangible common equity. We're happy to see the return on assets at about 1.3%, even after adjusting for items, and for the return on tangible common equity to exceed 14%. We continue to work hard to further strengthen these Measures and with higher capital distributions, we expect the return on tangible common equity to continue to strengthen.
Pre-provision net revenue, as depicted on Slide six, has performed particularly well, rising 16% over the past year and nearly doubling since we embarked on our efficiency initiative in late 2014. Adjusted for the items noted on the slide, our pre-provision net revenue increased 15% from the year ago quarter. We have said and continue to expect the pre-provision net revenue growth rate to be in the high single digits without giving consideration to additional interest rate increases by the Federal Open Market Committee. We're seeing momentum in several areas of revenue growth, including several areas of lending, such as residential mortgage, owner-occupied properties, and municipal lending, in trust and wealth management, and other select areas within fee income. Meanwhile, costs, both interest-bearing liability and non-interest-bearing expense, have been relatively well contained.
On Slide seven, you'll see the strong credit trends depicted on the chart on the right with classified loans declining a very strong 37% from the year ago period and 17% from the prior quarter. Improvement in oil and gas loans was a major reason for the improvement. For the third quarter, we experienced net credit recoveries of $1 million, or about one basis point of loans annualized. Net charge-offs for the last four quarters were only one basis point of average loans. We expect a low overall rate of net charge-offs in the months ahead, assuming current economic conditions remain generally stable. Additionally, as you can see from the allowance ratios, we're still maintaining strong coverage of non-performing assets and other problem credit metrics.
We continued to adjust upward our qualitative factors to reflect stressors that can be observed in the economy generally, such as the implementation of tariffs, higher interest rates, and the effect that they may have on certain borrowers, and higher oil and gas prices, which may reduce profit margins for certain commercial businesses and drag on consumer spending, et cetera. Quantitatively, however, we have not seen a credit deterioration within the various portfolio types. Slide eight is a list of our key objectives for 2018 and 2019 and our commitment to shareholders. We've presented this slide in prior earnings calls and at industry conferences throughout the year, so I'll avoid reading the slide to you. I'm pleased with the progress we've made on so many of these initiatives, all of which set us up to increase our return of capital to shareholders.
We increased that rate from about 20% of earnings to more than 110%. We view an increase of balance sheet leverage as appropriate, particularly given the reduction of the risk profile of the company. The decision on the magnitude, timing, and form of capital return is a board-level decision. To preempt the question, the board meets later this week to discuss, among other things, capital returns such as share buybacks and common stock dividends. With that overview, I'll turn the time over to Paul Burdiss to review our financials in additional detail. Paul?
Thank you, Harris, and good evening, everyone. Thank you for joining us. I'll begin on Slide nine. For the third quarter of 2018, Zions' net interest income continued to demonstrate growth relative to the prior period. Excluding interest recoveries as detailed on the slide, net interest income increased $40 million to $562 million, up approximately 8%. With respect to the revenue components, I'll start with volume and move to rate in just a moment. Slide 10 shows our average loan growth of 3.5% relative to the year-ago period. Although not listed on the slide, the period end growth in the third quarter relative to the second quarter was an annualized 5% with strength weighted toward the end of the quarter. Average deposits increased about 3% from the year-ago period and increased an annualized 5% from the prior quarter.
Thus far, we've been able to achieve this growth of balances with a relatively modest increase in deposit cost. This speaks to the granularity and overall quality of our deposit franchise, as we discussed in detail at our Investor Day this past March. Examining loan growth a bit closer, Slide 11 depicts our year-over-year period end loan balance growth by portfolio type. With the size of the circles representing the relative size of the portfolio. For most categories, we experienced solid and consistent growth. There are three areas where 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 $240 million. Within non-oil and gas C&I loans, relative to the prior quarter, we experienced an annualized attrition rate of about 4% on our larger loans.
That is, loans with balances greater than or equal to $5 million, while experiencing annualized growth rate of about 4% on our smaller loans. The incremental competitive pressure on larger commercial loans seems to be coming from capital markets activity and some loosening of credit standards among competitors, including unregulated senior debt funds. We experienced relatively consistent growth trends in one-to-four family and home equity loans and experienced a slight uptick in the growth rate of owner-occupied, which are generally small business loans underwritten based upon the cash flows of the borrower and secured by real estate. Oil and gas loans have increased moderately. Resulting primarily from a relatively strong increase in upstream and midstream loans while oil field services declined slightly. Municipal loan growth has also continued to be strong during the past year.
To repeat what I mentioned on last quarter's call, 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 comfortable with the growth and expect growth to remain strong in this area. Although we are optimistic in the near term about the growth of loans based upon the relatively strong economic backdrop, an improvement in small business loan growth and review of pipelines, we are also seeing some factors that may result in some growth pressures, including debt funds and capital markets that are highly competitive for pricing and for term, which affects our larger loans and underwriting standards that are softening within loans remaining in the banking industry, as noted in the recent editions of the Senior Loan Officer Survey.
A pricing that may not satisfy our risk reward appetite. Therefore, we are modifying our 12-month outlook for loan growth to slightly to moderately increasing. Slide 12 breaks down key rates and cost components of our net interest margin. The top line is loan yield, which increased to 4.71%, of which about two basis points are related to the previously mentioned interest recoveries. The yield excluding interest recoveries has increased about 40 basis points over the past year, which is a loan yield change of slightly more than 50% relative to the change in the Federal funds rate. Relative to the prior quarter, the yield on securities increased slightly. The shorter duration of the investment portfolio in combination with new security purchases, which were accretive to the yield of the portfolio, helped lift the yield overall in the investment portfolio.
While the premium amortization is very difficult to forecast, assuming stability in that area, we expect the yield on the securities portfolio to move higher at a moderate pace over the next several quarters and years based upon the yield of the securities we are purchasing. The cost of total deposits and borrowed funds increased five basis points in the quarter to 0.45% or 45 basis points, resulting in a funding beta of about 30% for the year-over-year figure. As a reminder in this case, beta refers to the change in the cost of deposits and borrowings relative to the change in the cost of the Fed funds target rate. The total year-over-year deposit beta was about 21% relative to the prior quarter was 29%. Cumulatively, since the beginning of the rising rate environment, we've experienced a total deposit beta of about 11%.
These elements combine to result in a net interest margin of 3.63% for the quarter, which increased seven basis points from the prior quarter and 18 basis points from the year ago period. Excluding interest recoveries in excess of $1 million per loan, the net interest margin beta was 21% over the prior year and 26% over the prior quarter. We believe it is reasonable to expect deposit competition to intensify somewhat over the next several quarters. If so, the net interest margin beta, if I can use that term, may be modestly less sensitive when compared to the recent quarter. Next, a brief review of non-interest income on slide 13. Customer related fees increased 2.5% over the prior year to $125 million. The primary source of income that increased and decreased are listed on the page.
We continue to work hard to increase our fee income, although the fees from treasury management are influenced to a degree by deposits and market rates for earnings credits applied to those balances, which in a rising rate environment create a slight headwind in our fee income trend. Similarly, the fee income realized from mortgage banking activity tends to be a little countercyclical, slowing and possibly decreasing as the economy strengthens due to the effects of higher rates on refinancing activity. Non-interest expense on slide 14 increased to $420 million from $413 million in the year ago quarter. However, adjusted non-interest expense, which is just for items such as severance, provision for unfunded lending commitments, and other similar items, non-interest expense was very stable at $416 million versus $414 million in the year ago period.
A portion of the increase relates to additional compensation that we announced in conjunction with the Tax Cuts and Jobs Act, which will be paid to most employees making less than $100,000 per year. These items account for about a $3 million increase over the year-ago quarter. With the holding company merger in the rearview mirror, along with other items in the professional and legal line item, we experienced a slight decline in that line item, and we expect the quarterly level to remain a bit lower than it had been during the past year or so. Also, as noted on the slide, we had a one-time adjustment to our FDIC deposit insurance cost in the third quarter.
Assuming the deposit insurance fund reaches 1.35% and the insurance surcharge is removed, considering our issuance of $500 million of senior unsecured debt late in the third quarter and the movement of other unsecured debt out of the holding company and into the bank as the bank and the holdco have now merged, all of these things combined would result in a lower insurance cost relative to other secured funding. As a result, we expect our FDIC insurance expense in the fourth quarter in all of those cases to be about $7 million.
Turning to Slide 15, the efficiency ratio is 58.8% compared to the year-ago period of 62.3%. We reiterate our commitment to achieve an efficiency ratio below 60% for the full year 2019, excluding the possible benefits of rate increases. Finally, on Slide 16, this depicts our financial outlook for the next 12 months relative to the third quarter of 2018. In the interest of opening the line up for questions, I won't read the rest of the slide to you, but we will be happy to take questions about any of these items. 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 Dave Rochester of Deutsche Bank. Your line is open.
Hey, good afternoon, guys.
Hey.
Just a question on capital. Now that you guys are effectively out of FSOC, you got more clarity and control over where capital levels go from here. I know you talked about bringing the CET1 ratio down to just above pure levels in the next six quarters or so. It seems like that would imply a decent step up in the buyback going forward, especially if loan growth is maybe not a solid mid-singles in terms of growth going forward. Is that a fair statement, and any rough sense as to what that means in terms of dollars over the next year?
It's certainly fair. You've done the math appropriately, I think, Dave. We're simply reluctant to be too specific about it because our board hasn't met, and I don't want to front run them.
Yep.
It would certainly be our view that kind of target is still achievable, and that's the discussion that we'll be having with the board here at the end of this week.
Okay. No, that's fair. I appreciate that. I guess, some of your peers have talked about reducing ratios over time as well, and are talking about lower levels than where they are today. I know your discussions have talked about based on where your peer capital ratios are today. If we're talking about lower peer ratios over the next 6 to 8 quarters, are you guys still thinking about walking your ratios down as well versus the targets that you have been talking about over the last quarter or so, if that makes sense?
Yeah. I guess I'd answer it by saying, fundamentally, we're not going to determine what our capital ratios ought to be primarily by looking at where peers are. We're going to continue to do stress testing. We expect to do that actually probably quarterly and let that inform the discussions we're having with the board. To the extent that the result can lead us there, that's one thing. We're not going to be chasing peers. It's not a race to the lowest possible capital ratio necessarily. It's trying to have the right amount. I think especially where we probably should be, at least in the cycle. It's hard to know maybe where we are. Kind of in uncharted waters in terms of what this recovery's looked like. We certainly don't want to go into a downturn behind the pack.
That's how we're thinking about it. We're really fundamentally going to use stress testing to inform how we discuss it with the board. I think at the present time, we see enough room to get down to pretty close to where the peer median is.
Okay, great. Thanks, guys.
Thank you. Our next question comes from the line of John Porcari of Evercore. Your line is open.
Good afternoon.
John.
On the loan growth front and in terms of your guidance, I know that you softened it a bit there. Can you give us just a little more clarity around what you're actually seeing that's driving you to push that lower? What type of competitive pressures on terms and pricing, what types of portfolios are you seeing that happen? Thanks.
I'll give you an example that I heard just at the end of last week. Over in Colorado, I was being told about a $30 million commercial real estate deal that went to the CMBS market. It was 10 years interest only, covenant light kind of deal. That's not where we're going to play. That would be an example. I don't know, Michael, if you have any other comment about that.
Sometimes with owner-occupied, you don't really know what the industries are that are growing. Owner-occupied is a focus for the company. We like what comes with it in terms of ancillary business and relationships. I think we're very pleased to see that category grow.
Okay.
John, this is Scott. I'd just add that the area of our portfolio or activity that's the most volatile really is, it's the larger transactions like the CRE term credit that Harris described. We'll see it in the large energy credits also. We've experienced more payoffs than we anticipated there. Generally, it's just some remaining problem credits that are paying down, so that's actually a good thing. As you know, we don't have a big exposure to larger loans. The exposure we do have is just more volatile because of the conditions that have been described. If you look at slide 20, though, in the deck, what you see is really solid growth year-over-year. A real bright spot is our smaller affiliates, in Colorado, Arizona, Commerce Bank in Washington and Nevada.
They represent about 25% of the company, they're producing about 50% of the loan growth. That's really a healthy thing. As Michael noted, by loan type, owner occupied is C&I and collectively that's growing nicely. Our mortgage related business, whether it's one to four family or the HELOC portfolio are growing nicely. We're actually seeing some growth coming from energy again. It's a nice mix of loans by type, and it's coming broadly across the company, particularly from our smaller affiliates.
Got it. Thanks, Scott. That's helpful. That leads me right into my second question. Given that, what can change? To get your loan growth back up here, because obviously given short of a downturn in the credit cycle, I'm not sure that the competitive environment really changes here. If we assume that the competitive environment remains relatively intense, is there any reason to expect your loan growth can strengthen from here?
I think it's hard to know. The third quarter was a good solid quarter for us, and fourth quarter generally is a good quarter, so it's hard to know. I think the reason we lightened our guidance just a little bit is because of the volatility in these larger loan transactions. They're just lumpier. That's I think what we were trying to say.
No, I get it. Thank you. We favor the better credit anyway, so thank you.
Thank you. Our next question comes from the line of Ken Zerbe of Morgan Stanley. Your line is open.
Great. Thanks. I guess first question, in terms of your average balances on the liability side, looks like you paid down a fair amount of borrowed funds in the quarter, call it maybe $800 million, $900 million. Could you just remind us, like what that is and should that borrowed funds stay relatively constant just given the more moderate pace of asset growth?
Yeah. This is Paul, Ken. We use that as a balancing mechanism for the balance sheet as we think about overall kind of loan growth and what we're doing with the investment portfolio. What deposits are doing and stability and growth of deposits. That ends up being kind of the balancing component there. That number is really just going to be, if it makes sense, kind of what it needs to be. A lot of that is our home loan bank borrowings. We are becoming more active in the senior note market. You saw that issuance this past quarter. I would expect to see the composition of that funding change over time, similar to what you saw here over the last quarter.
Got you. Okay. Perfect. Just as a follow-up question separately, can you just remind us how big is the municipal loan portfolio right now and kind of what are your designs on growth in that over time? Thanks.
Yeah. You can see it actually on page 12 of our press release. Currently, municipal loan portfolio is about $1.5 billion. That's grown from about $1 billion a year ago.
Got it, okay.
We're going to continue to expect to see growth as we invest in that business.
Got it. Understood. All right. Thank you.
Thank you. Our next question comes from the line of Erika Najarian of Bank of America. Your line is open.
Hi. Good morning. Good afternoon, rather. Sorry about that. Just wanted to ask a follow-up question to John's line of questioning. I guess, as we think about where the non-banks aren't playing, how would you help us size your portfolio in terms of what you think is a more defensible business from the non-banks, whether it's the municipalities or owner occupied or a part of your real estate portfolio?
I guess I'd say that, I think we're relatively speaking in a pretty good place because we have a significant portion of our portfolio is in generally smaller credits. We're not a big corporate banking player. Even with these municipal credits, we're trying to focus on kind of smaller municipalities, where we think we can actually create a little more value for them and for us. Owner occupied, a lot of what we do there is kind of small to mid-size businesses
That's certainly true of a lot of our C&I portfolio generally. I think those are really a pretty good place on deals that are kind of $1 to $5 or $6 or $7 million, don't tend to find their way into loan funds. They don't tend to get picked off by online lenders, et cetera. Our competitors there are largely community banks and other regional banks.
Erika, this is James Abbott. I'd add that we do have some slides in our Investor Day materials back from March that give you kind of a sense of the size of the commercial loan portfolio, so the small loans versus the medium size and large size loans. That's a resource that you could potentially utilize. We do have a very substantial portion of our C&I portfolio, for example, is loans that are less than $5 million in balance. We did see very good growth out of that during the quarter. I think quarter annualized a little over 4% was a very strong performance while some of the larger stuff did decline.
Got it. Just to follow up on the color that you provided with regards to margin expectations going forward, we're hearing you loud and clear on the deposit side. I'm wondering if you could give us a sense on what spreads are looking like right now, and whether or not sort of the lower burden as a non-SIFI changes your strategy about securities reinvestment.
Yeah, Erika, this is Paul. There's a lot in there. Deposit beta we talked about, maybe don't need to get into that too much more. Loan spreads have been generally behaving, keeping in mind sort of where we operate and your conversation about kind of the average size of loans. That has impacted our ability to defend loan spreads, although I will say the composition of the portfolio has changed a little bit. For example, if you look at our portfolio from a year ago, we had more commercial real estate relative to residential mortgage than we do today. The spread, as you know, and that's just two examples, or maybe one combination example, but the spread is very different among those products, residential mortgage having a tighter spread.
While we're generally on a deal-by-deal basis, we've had some success maintaining and defending spreads. We are seeing a slightly different composition of the portfolio, which is impacting overall loan spreads. As it relates to the size of the investment portfolio, while it's true that we're no longer subject to the LCR, our biggest constraint really is our liquidity stress testing as opposed to the LCR. I am not forecasting or would not predict a big change in the composition of our investment portfolio, because that liquidity stress testing continues to be a really important part of the way we're managing our balance sheet. Overall, as I said in my prepared remarks, we've had, if I can use the term, a pretty decent relative to expectations, a pretty decent net interest margin beta.
As you know, we've got a slide back in the appendix that provides a little more detail on the interest sensitivity, particularly the asset side of the book, relative to market rates. Our performance has been very much in line with our modeling and our expectations. Looking ahead, again, considering deposit betas and other things, maybe we don't squeeze as many basis points out of a Fed tightening as we have over the past kind of year and a half. We expect it to continue to for the modest margin expansion as the Federal Reserve continues to raise rates.
Got it. Thank you.
Okay.
Thank you. Our next question comes from the line of Ken Usdin of Jefferies. Your line is open.
Thanks. Good afternoon, guys. Just to follow up on the deposit side, I noticed that you had good year-over-year growth, 3%, and the non-interest bearings were actually quite stable. Even amidst this deposit pricing pressure we're seeing, can you just give us a little color in terms of where you're getting that incremental growth from and your continued belief in the stability, especially of that non-interest bearing, where we're starting to see that really come down in a lot of other peers? Thanks.
Yeah. Hey, Ken, this is Paul. I'll start and Ken or Scott can kind of fill in. If you go back to Investor Day, we talked a lot about the composition of our deposit book, and the fact that it's very granular, very operating in nature. If you think about deposits in terms of kind of operating deposits and kind of "investment deposits," our proportion of those operating deposits is actually pretty high. All that being said, the stickiness of our DDA has actually been sort of a pleasant surprise for me. I don't want that to sound negative, but our interest rate risk modeling actually anticipates that we will have more migration out of DDA than we have experienced.
I think the fact that our DDA has been so sticky is really an indication of the strength of the deposit base, and the kind of overall strength that that provides to the organization.
As a follow-up, Paul. Oh, go ahead.
This is Scott. I would just add to that our ratio of non-interest-bearing deposits to total deposits, for decades, several decades, has been almost industry leading. We're sitting at 45% today. Most of our peers are in the kind of the mid to low 30s, high 20s. Even before 2008, our relationship of non-interest-bearing to total deposits was very favorable, and it's for the reasons.
That Paul described, but just to add some punctuation to that. About 65% of our $24 billion in non-interest-bearing deposits in some way touch our Treasury management products, which just reinforces the point that these are operating balances of these businesses, and they're generally smaller businesses. What I'd suggest is that generally these are smaller companies, and they're focused totally on how to enhance their gross profit margins, which may be 15%-30%, as opposed to how to get an extra 25 basis points out of their operating account.
Makes sense. Thanks, Scott. Just as a follow-up to that, can you detail just is it the consumer side versus the corporate that's been growing? Because there's also been a lot of talk about the stickiness of consumer, not as much of a focus for you guys, but a big part of the bank it is. What side of the bank is growing when it comes to deposits for you guys? Thanks.
It'd be mostly commercial.
Yeah, it's been.
Yeah
mostly non-personal. They're commercial deposits.
Okay. Got it. It feeds to Scott's point. Thanks, Scott.
Right.
Thank you. Our next question comes from the line of Steven Alexopoulos of JPMorgan. Your line is open.
Hey, everybody. Wanted to start, Paul, for Paul at expenses. You guys seem to be running at the low end of the 2%-3% range that you previously talked about. Do you think that's sustainable going forward?
Look, we are and have been really investing in our business. I'm really proud. The organization has really come together and we are creating opportunities to change, if you will, kind of the composition of the way that we're investing in the business. We're saving money in spots, and we're investing money in other spots. As we look ahead into kind of 2019 and beyond, we're right in the middle of our budgeting process. We're very focused on expense control. We're very focused on positive operating leverage. So, yeah, in the near term, I absolutely think it's sustainable.
Okay. Great. Then just one other one for Harris. Given the valuation of Zions' stock here and now that you're officially out of CCAR, do you have an appetite, as you meet with the Board, you're the Chairman of the Board, obviously, to accelerate buybacks and get to the targets more quickly?
I do. I am one vote out of 10, or 11, rather. Again, I don't want to front-run that conversation. I think that, clearly valuation is one of the things we need to think about, and it is the silver lining to what I am seeing in the bank stock market these days.
Is the fact we have got a lot of capital to deal with. That is how I am thinking about it.
Okay. Great. Thanks for the color.
Thank you. Our next question comes from the line of Jennifer Demba of SunTrust. Your line is open.
Thank you. Can you hear me?
Yeah. Hi, Jennifer.
Hi. Harris, just wondering if you can talk about the level of lending competition you're seeing and kind of compare and contrast that to what you saw right before the last downturn.
I think there's a whole lot of liquidity out there, a lot of cash. It's very competitive for earning assets. I don't know quite how to compare it to before the last downturn. That was, I think, clearly more housing kind of driven. A lot of demand for developer credit. I think there's actually quite a lot of discipline today around that, not only here, but generally from what I think we see around the industry. I think the thing in that respect is probably fundamentally different. You are seeing there's been a lot of growth. You see it's not quite so much where we play in leverage lending, but clearly, big players there.
They're seeing a lot of competitive pressure from hedge funds and loan funds and others that I think should be of maybe some concern in terms of where the next problems could pop up.
This is Ed Schreiber. I wanted to supplement some of Harris' comments. More importantly, look at our book. When you really look at what we've done over the last few years, the balance sheet has been simplified. More importantly on the credit side with Michael Morris, the Chief Credit Officer, and his staff, we've really designed a program in here that you've seen and exemplified through the oil and gas cycle that we're really a big fan about positioning the company as a positive outlier through the next cycle. If you're really looking at any forecasting, I think the way we position the company from an asset quality perspective is that we're in good shape, and we would be a positive outlier through this next cycle.
Thank you very much.
Thank you. Our next question comes from the line of Jeffrey Elliot of Autonomous Research. Your line is open.
Hello, thank you for taking the question. First, just a little clarification. I think in the prepared remarks you touched on the impact of the simplification of the corporate structure on expenses. Can you remind us what the benefit is you expect from that? How do you quantify that?
Yeah, I didn't specifically quantify it. Jeff, this is Paul. I didn't specifically quantify it, but what I did say effectively was that we have seen some escalation or elevation in that professional services line over the course of the last kind of near term, and that we would expect maybe the run rate of that to be a little bit lower. That was, I'd say, the key part of the prepared remarks, I think, that deal with what you're describing. Keep in mind that we did not have a lot that happened at the holding company. Nearly all of the assets and essentially all of the operations and all the employees have been at the bank level for some time. While it does create organizational simplification, my expectation is not that we would see a kind of stepwise change in our operating kind of expenses.
Then on the deposit side, I guess you're somewhat unusual in kind of operating separate brands and separate banks, if you like, in different geographies. How much flexibility is that giving you to adjust pricing in different markets, and how much variation are you seeing in competition if you kind of compare the main markets you're in?
Well, we price locally. The pricing decisions about deposits are made by local management teams, and they certainly have incentives to try to minimize their funding costs. We have internal transfer pricing as every larger bank would have to try to compensate them for the funds that they're raising. They're trying to make spread. There's a spread on both sides of the balance sheet. I don't know what more I'd say about it.
This is Paul. If I could, I would probably ascribe more value to sort of the local nature of the banks as opposed to the local brand of the banks.
Yeah.
I think your question was really around the brand. I think the value is really around the way we're run and the autonomy of the local groups and being able to react specifically to what their client needs at a very local level, I think is providing a lot of flexibility for us as we're thinking about deposit pricing.
Great. Thanks very much.
Yeah.
Thank you. Our next question comes from the line of Christopher Spahr of Wells Fargo. Your line is open.
Thanks for taking the question. With high single-digit PPNR, how low do you think the efficiency ratio can go?
I don't know. It sounds like a game of limbo.
I'll just start out and ask Scott and Harris to jump in here. As I said, we're really focused, not necessarily on the efficiency ratio as sort of the end goal. We're really focused on positive operating leverage. If we can continue to achieve that, we are going to continue to see very strong PPNR growth and continue to grind that efficiency ratio lower.
I would make one observation, because we've talked a lot about the deposit base and the loan mix, and it is a little different than you find in some of our peers. It is a little more expensive to operate. We'd hope that shows up in the form of the kind of deposit performance you're seeing right now. That probably creates a little bit of drag. I think nevertheless, my hope would be that we find ourselves getting down into the mid-50s over the next couple of years. That would be just kind of generally my aspiration.
I'd just add to that, as Scott did, going back to Steven's questions about the expense growth rate of 2%, 3%. Basically, we are building our plan around that expense trajectory that we've talked about. That involves investing actively in the businesses that we're trying to grow and investing actively in technology. We're not just sitting back cutting costs everywhere and not investing in the future. We've been investing heavily in the future over the last three or four years, both in terms of technology and in terms of businesses we're trying to grow with hiring new bankers et cetera.
Thank you.
Thank you. Our next question comes from the line of Steve Moss of B. Riley FBR. Your line is open.
Good afternoon. On the loan growth front, with particulars on resi. Also on oil and gas, just wondering what are your thoughts for growth going forward in both those categories? Also, what are you retaining with regard to resi mortgages these days?
Yeah.
Go ahead, Scott.
Go ahead, Paul. Well, I was just going to say, our mortgage business is very different than the mortgage business you would find at the major mortgage lenders in the country. Our business is basically a private banking business, although we do have a very broad consumer business also. It basically is about 50% of our mortgages are for small business owners. I think they're generally not first-time home buyers. Our mortgage volume is down a little bit this year versus last year, but not nearly like the rest of the industry that you read about in the paper every day. We're pretty bullish on our mortgage business, and we retain about, Paul, I think it's about 60, 70% of what we originate. We're basically retaining everything under 10 years.
We're about to introduce a new online digital application process that we think is going to be a real game changer for us. We're not a big player, but a game changer for us. That's in pilot right now, and be rolling out next year. On the energy book, it's about $2.2 billion in outstandings right now. It got down to about $2 billion. Went from $3 billion to $2 billion. That was the contraction. Just in the last couple of quarters, it's grown back to about $2.2 billion. I think 10%-15% kind of growth in that portfolio would not be unusual at all. It's basically reserve-based lending and midstream. There's virtually no growth coming from our services business, and we've consciously held back in that area.
Okay, that's helpful. With regard to securities balances here, I know on an EOP basis, they're flat. Just wondering, what are your expectations for those balances going forward?
This is Paul. I'm not expecting a big change in either the size or the composition, although that may change as deposit growth ebbs and flows and loan growth ebbs and flows. Generally speaking, I expect that portfolio to remain relatively stable, just overall size.
All right. Thank you very much.
Thank you.
Thank you. Our next question comes from the line of Marty Mosby of Vining Sparks. Your line is open.
Thanks. I have three quick questions. One is the warrants that were outstanding were causing some dilution as the stock price was going up. The share count dropped pretty precipitously this quarter. Was some of that the benefit of the kind of reversing out of some of that impact?
It was some of it. This quarter, I think if you look at average share price quarter-over-quarter, even though it maybe went up and went down, I don't know that the average is a whole lot different. I think a lot of the positive impact you're seeing there is the result of the share repurchase activity.
I think last quarter, Marty, it's about a half a million shares is all is the difference. Obviously we'll have to see what the stock price does in the fourth quarter here, but if it stays where it is, it'll be a more substantial improvement on the diluted shares.
Okay. Paul, you were talking about the FDIC costs, and I was kind of hearing that because you had consolidated and you'd done some debt, that maybe your FDIC costs are just going to go down without kind of the surcharges going away. Could you just maybe explain just the number, what it was this quarter, next quarter, and what you expect it to be kind of as that rolls forward?
Yeah, Marty, I probably wasn't as articulate as I could have been as I went through that part of the prepared remarks. You're right, there are a couple things impacting FDIC this quarter. The key one is we had sort of this incremental accrual of $3.7 million. That shows up in the third quarter. That was kind of a, if I can use the term, sort of a one-time thing. It's isolated event. It's not going to happen again next quarter. The other aspect is we issued unsecured debt in the third quarter. We had a little bit of debt that was holding company notes that have now been assumed by the bank. As you know, unsecured debt gets a very favorable treatment under the FDIC calculator. There's also going to be an incremental benefit of that.
That's probably going to be close to $1 million a quarter. The other big one, of course, is the FDIC surcharge. That'll affect us as it affects everyone else. Just as a reminder for us, that FDIC surcharge is a little under $6 million a quarter.
Perfect. The last quick question is, your biggest portfolio is C&I, excluding oil and gas, and it's declining. It's tough to see the momentum building in the portfolio with that one still kind of seeing a modest decline. Almost all of that decline back on page 20 is coming out of Amegy. I was just curious what was the loan type or the decisioning around because it was a big number in this quarter, but it looks like it had been consistent over the past several quarters. Just curious what was causing that decline.
I'll start, and then I'll ask Scott and Michael and whoever else want to make a comment. Marty, as I'm thinking about C&I would also include owner-occupied in that. I think owner-occupied is a really important aspect. It just, as you know, happens to be secured by commercial real estate, but it's really sort of a commercial loan disguised as a commercial real estate loan because it's owner-occupied. As you combine C&I and owner-occupied, there actually has been growth over the course of last year. Scott or Michael, would you like to add any of that?
No, I would echo what you said, but I would also point to Amegy's growth in owner-occupied. There has been growth in the Texas market in C&I, and we always include owner-occupied under the C&I umbrella, as Paul mentioned.
The only thing I'd add to that is that that portfolio, it has more exposure to larger transactions than most of our other portfolios. In the C&I space, the volatility we talked about early in the call, Amegy is a place you would definitely see it in the C&I non-oil and gas. Exactly. Right.
All right. Thanks.
Thank you.
Thank you. Our next question comes from the line of Don Koch of Koch Investments. Your line is open.
Hey, thank you guys. You sort of had a bang-up quarter. I'm just sort of flexed. I mean, an outstanding quarter. I'm looking at your slide from your investor day, and your main bank is a little less than a third of total bank assets. Are you finding that there's some kind of fallout? I know historically, when you do these consolidations like Regions did and Synovus and the old Barnett and UCBI, it takes several quarters for those directors to sort of come back to the family and the salary mechanism of individual banks versus one bank all working out. Can you make any statement about why you did so well in the quarter, so really outstanding, but yet the stock so sharply fell?
It broke up in the last phrase there.
Why is it, if I were to be a betting man, I would've bet that the stock in the last quarter would've sharply gone up from your phenomenal numbers. You're knocking the socks off the ROA and the ROE, but there was such tremendous pressure, downward pressure, stock from this consolidation. Do you have any explanation of that?
Well, I don't know if it was from the consolidation. I would say it's tough enough to manage a bank without having to manage the market too.
Right. No, I understand. I know, and it's a guess, but are you seeing any fallout from the individuals that were part of these individual banks that you all put together?
Listen, I think fundamentally, the answer is no. We've got enough employees that on any given day, yeah, we got people who get picked off by others. We sometimes pick off other people as well, but it's been very stable kind of in the management ranks of the company. It's been very stable.
They're paid the same way and the incentives are the same?
Yeah. Fundamentally, there hasn't been a lot of change there. The customer-facing employees in this company, fundamentally, almost all of them, not totally, but most all of them report to these local market CEOs.
Right. Mm-hmm.
What we call these affiliate CEOs. That group has been extremely stable.
Good.
We just haven't seen the kinds of issues you see kind of going through this. The consolidation was not a huge deal for the customer-facing people. Now, it's had some impact certainly in kind of some back office functions and places like that. The revenue drivers, we've tried to be pretty careful about those.
In fact, this is James. I'll just jump in here. We've got just a couple minutes left, and I'd say one of the, Harris, you've said many times at conference appearances, is that we made this decision to consolidate because of the feedback we were getting from the frontline employees to help make their lives simpler. We're not going to be able to make it to everybody's question today it looks like because of time, let's just take two more questions, and we'll go lightning round for these last two, and then we'll be at our time limit.
Thank you. Our next question comes from the line of Lana Chan of BMO Capital Markets. Your line is open.
Hi, good afternoon. Just to follow up on the capital return discussion, could you talk about your appetite for acquisitions, whether whole bank or loan portfolios or business lines?
Well, I think we said for some time, you never say never. It's not something that is not a strategic priority of any sense. We'd be very opportunistic, I guess, if something was a great fit. It's not something that we spend a lot of time thinking about.
Thanks, Lana.
Thank you. Our next question comes from Brock Vandervliet of UBS. Your line is open.
Oh, thanks very much. I had to jump off for a while. Harris, I thought I heard you mention 55 or mid-fifties, I guess, efficiency ratio. It doesn't seem like that would be necessarily, in the near term anyway, top line driven. Are you feeling better about the scope for expense saves here on the back of some of the charter consolidation or vis-a-vis your improvement in terms of your regulatory situation?
Well, when I talk about mid-fifties, I use the word aspirational. I'm not suggesting that's going to happen in the next few quarters. I do think that that's achievable with kind of our business model if the economy continues to remain reasonably healthy. I do think that we'll continue to see revenue growth driven by kind of reasonable loan growth. I think we worry a little in the short run about competitive pressures on some of the larger deals, as we mentioned. That's not fundamentally what the major part of this franchise is. I think over time, as we continue to focus on where I think our sweet spot is, I think it's not an unreasonable kind of goal.
Appreciate the color. Thank you.
This is James Abbott. We appreciate, thank you, Latife, for hosting the question and answer session. Thank you all for joining the call today. Please don't hesitate to contact me if you have additional questions or comments. My information is on the front of the press release. We look forward to seeing many of you at industry conferences during the balance of the year. Thank you again for your participation. We wish you a good evening.
Ladies and gentlemen, this concludes today's conference. Thank you for your participation.