Right, thanks everyone for joining us. Up next we have Zions. I'll just read a quick disclosure. For important disclosures, please see the Morgan Stanley Research Disclosure website at morganstanley.com/researchdisclosures. The taking of photographs and use of recording devices is not allowed. If you have any questions, please reach out to your Morgan Stanley sales representative. With that, we're delighted to have with us today Scott McLean, President and Chief Operating Officer of Zions. Scott, it's great to have you here.
I'm great to be here. Thank you very much.
Scott, I wanted to start with the overall environment, get a pulse check on what you're seeing. During the first quarter call, Harris highlighted that the level of uncertainty from tariffs was negative for sentiment across businesses. Since then, we've had a few positive announcements. How has that impacted customer sentiment?
Thank you, Manan. I, you know, customer sentiment still, there's a lot of uncertainty. The genie is out of the bottle on tariffs, and I do not think anyone can put it back in, in terms of the mindset, the psyche of small and medium-sized business owners. You know, about 65-70% of what we do, of our revenue and our deposit balances, are banking small and medium-sized companies in the country. They, whether tariffs are on or off, just the threat of it will cause them to take action. I think with small and medium-sized business customers, they're immediately thinking back about COVID and the pandemic, and what they had to do there was to make sure that they had inventory. In many cases, they could not. You've got a gross profit margin of 20-40%.
They learned they are never going to be without inventory again. I think what you're going to see is that small and medium-sized businesses will move, they'll increase inventory, move their supply chains back to the U.S. more, whether tariffs stay on or off. The threat of it is enough to do that. I think that actually will probably be a good thing for loan growth ultimately. I think really big companies, it's a different story.
I think for them, it's more about capital investment, and it just is going to be really difficult for CEOs and executives of large public companies to go in and commit to a three, five-year capital investment and be able to talk with any certainty about long-term rates, inflation, the price of their products, all the kinds of things you would want to have some certainty about if you were going to make an investment.
It sounds like from these large capital investments, that's still on hold a little bit. For the smaller businesses, you are seeing some inventory build here?
Not yet. Not yet. I mean, this story really just started in the first quarter. I think there's still kind of a wait and see that's going on. You know, when you think about where we were a year ago or 18 months ago, what did we think 2025 would be like? I think we thought there'd be some kind of recession. I think we were really concerned about CRE. When you kind of go back and with that historical lens, basically, I think most people feel like we'll have lower GDP growth, but probably a positive operating environment, clearly with a little more volatility.
I think the whole CRE topic, while there's risk in CRE loan portfolios, I think people are more comfortable with where that stands now, and they can see the underwriting, the post-2008 CRE underwriting, which was dramatically different than pre-2008, really holding these portfolios up pretty nicely. It certainly has for us.
Zions operates separate entities in many different markets: Utah, California, Texas. Are you seeing any different trends in any of the markets?
We're really not. You know, the customer survey work that we do is pretty consistent across, you know, we're in 11 western states starting in Texas and going to the west. Really the only thing that we're seeing a little different right now is our loan growth in Texas has been stronger. It was stronger last year. It is stronger through the first quarter than it is in our other states. Really the operating conditions, I think, across our affiliates are pretty similar right now in terms of how customers are feeling and what they're doing. I would say, though, for investors, we do operate in these different states, and sometimes that's confusing to investors. We look decentralized. Our technology and back office have been consolidated since the early 2000s.
In the last 11 years, we had a lot of customization, even though we were highly centralized in operations and technology. In the last 11 years, we've taken most of that customization out. What is in these, our separate affiliates, is kind of the front end, the client-facing piece, which is what you would want there, the decision-making about client decisions, pricing, and some middle office activities. Most of it is the real revenue-producing strength of our company.
And Scott, another comment that you made in April was that there was more than the usual level of uncertainty around the one-year guides that you gave. Has some of that uncertainty reduced given that, you know, we've clawed back a little bit, we've pulled back a little bit from the peak in what could have been the peak in tariffs? Do you feel better about your guide today?
Yeah, I think the funny thing about guidance, and it drives you guys crazy, may drive some investors crazy, guidance is kind of there to help complete your models. We all understand what it's there for. I don't think, you know, you go back just five years, did anyone's guidance ever predict the pandemic? No. Did it predict Silicon Valley? No. Did it predict rates going up 500 basis points in 2022, Silicon Valley in 2023? Did it predict this tariff thing? Guidance, it just doesn't embrace any of that, really. That is why we work really hard to just make sure people understand the fundamentals of our business. That is pound for pound being one of the biggest banks for small businesses in the country, having national recognition in that regard. Our deposit franchise has national recognition. Our customer satisfaction scores are nationally distinctive.
We think our technology is now nationally distinctive as well. Those are all things I think for long-term investors, you know, I hope speak more loudly than actual guidance.
Yeah, so that's totally fair. Maybe we should dig into some of those more fundamental trends. On the loan growth side, you've spoken about focusing on the commercial side to drive loan growth from here. What are the biggest opportunities for the bank there?
Yeah, you know, commercial lending makes up about 50% of our loan portfolio. About 20% plus is CRE and another 20-25% is consumer, principally one to four family mortgage. The C&I side is very broad-based, a lot of just kind of fundamental general industry. We're seeing, you know, moderate activity there. Again, I think 3% loan growth doesn't really excite anybody, but the rest of the industry is kind of at that rate. I think investors should look at that growth rate and go, you know what, again, going back 12 months, if you look forward, maybe a national recession, I think 3% loan growth is not a bad thing from a health standpoint.
I think as we get through these tariff talks and maybe the economy becomes a little more certain, I think you're going to see loan growth pick up. We're also leaning heavily into our SBA lending activity. It's really exciting. We were the 20th largest SBA 7A originator. In their fiscal year end last October, we had originated 700 SBA loans. We're on track to originate 1,500 this year. It would take us from number 20 to about number 10. We just passed Bank of America, which is cool. They're a bank about 40 times our size. JP Morgan and Wells, assuming we get to 1,500, I think we will pass them shortly. Once we get to 1,500, that's a nice, that'll be nice three years of growth.
Our goal is to go to 3,000 in the following 12 to 18 months, which would get us in the top five. It is not going to change our stripes really as a company, but when you think about it, it is really granular growth. It will have a positive influence on C&I. It is very deposit-rich type of lending, and there is a nice fee income component and a consumer banking component to it. We finally just got kind of mad about it. We saw where our SBA rankings were, and we thought, man, who other than us should be leading the league in SBA lending? That is really what got us started. Harris Simmons, our CEO, just said, this is nuts. Off we go. It is going to be a fun part of the story.
To clarify, the 1,500, is that new client relationships or new loans?
It's a great question. And it's 7A. We do 504 also, so it's just a component, but it's an important component. And some of it is certainly to existing customers. But it's about 50/50 right now, and that number is going to change over time. But quite frankly, if we never brought in a new customer, which is not going to be the case related to this, you know, about 70% of small businesses don't borrow from banks. They might have a business credit card or they're financing it personally. So 70% of your small business client base doesn't borrow. And so this is just a way to deepen our relationship with those and generally help them bring their banking needs kind of all to one bank.
That gets you the relationship on the deposit side and the fee side and the lending side?
Yes, absolutely. It should. I mean, it doesn't just happen, you know, accidentally, but it, yeah, if we do our job as bankers. And most clients, when they get an SBA loan, it's kind of the difference between having a business or not having a business or really growing the business. I mean, it's a life event. Generally, if we show up with a, you know, financing, they're happy to do their business with us.
You spoke about loan growth activity should pick up at some point as the confidence builds. You're making all these new investments. Talk a little bit more about the steps you're taking to benefit from that loan growth activity once it picks up. What investments are you making? What hires are you making?
Yeah, you know, it's not what we'll do when the loan growth picks up that I think is as important as what we need to do to make sure it picks up. We actually have made some real nice strategic hires in Salt Lake, some very exciting news there in Denver and in California. We're always doing that. We are just highly focused on our fundamental call programs. I just refer to it as shoe leather. We were in this 10, 11-year period of modernization of our company with our big core transformation project, which was the first time it's ever been done in the United States. It's been done 300 times around the world. We're really the only bank in the country that has replaced its core loan and deposit platform. It's a really big deal.
That is the benefit of that is that it's allowing our bankers to spend less time with our systems and spend more time out with our clients. Our call programs, we have a customer appreciation calling campaign that we've been doing for a number of years. It's just a simple call. You just call a customer and say, hey, we appreciate your business. Any of our employees can do it. It's stunning. We'll do about 130,000 of these calls this year. It's stunning to see the anecdotal kind of positive things that come from it. We also are very aggressively calling on the prospects. We've kind of got a top 25% of the prospects in any of our market. It's about 10,000 names that we're calling on across the company.
A lot of banks just sit back and wait for referrals or business to come in. We've always been very forward-leaning in this regard, and that's an important campaign. I think the other element we're bringing forward is a new approach to marketing in our company. We've had really a solid approach to marketing, but I don't think it's been a strategic weapon for us, a strategic driver. We'll talk more about this as the next 12 months unfolds. We're going to be using much more active marketing that I think will be really helpful to our small business initiative and this SBA initiative, to our consumer deposit growth initiatives, and to all of our fee income products.
Got it. Maybe talk a little bit more about competition. I mean, you're clearly competing against not just other regional banks, but also the large money center banks in the small business arena. Talk about what you're seeing on the competition side right now and how that's been evolving over the past year or so.
Yeah, you know, Manan, I've been in this business for 46 years, and it's just always, I don't remember a time that wasn't competitive. You know, my main office is in Salt Lake, but I live in Texas, and folks have been parachuting into Texas, you know, for decades. We've seen a lot of banks come and go. The playbook that they run is increase everybody's compensation, you know, when they hire teams by 20-40%, maybe more, big bonus packages, blah, blah, blah. They lower pricing to win relationships and big money spent on marketing and sponsorships. It's just kind of a worn-out playbook. Some banks have done it okay, you know. In what we do, banking small and medium-sized businesses, there are always four to six proposals when we're trying to win a piece of business.
The fact that some big regional, giant regional bank or global bank wants to increase the branches in our market, blah, blah, blah, we just, you know, let them come on. Competition is a good thing. We are not worried about competing with anyone that wants to parachute into our markets. I think it's going to be a bad experience for them, generally speaking.
Especially in cases where you already have the client relationship.
Exactly.
Got it.
We will, when people run, hey, we're going to lower your price dramatically compared to what a Zions affiliate is charging. If it's a bank that has said they are going to dramatically increase their presence, we will fight like tigers. If they get it, they are not going to make any money on it, and they are not going to be happy with it long term. You know, we're a pretty nice squad, but we know how to fight when we need to.
The other aspect of competition is not just from traditional banks, but also from private credit. Can you talk about how you're thinking about Zions' relationship with private credit, both as a competitor and as a partner?
Yeah, it's something we all ought to be really worried about. You guys have written about it. Everybody's writing about it. The growth in private credit, I'm not going to quote numbers, but it's been dramatic. Generally, those providers of private credit, they're outside the regulatory environment. Their terms are normally longer. Their covenants are weaker. Their requirements for equity are less. When they're all in, it's a very, it's going to be a volatile type financing. When we're in deals with them, we just have learned to become very careful about our position relative to theirs. People think just because you're senior, somehow you have, you know, a great position in difficult negotiations. It's not always true. The more complexity in the capital structure, the more complicated it is for clients to work through difficult situations.
I think what's going to happen with private credit is that it's going to keep growing until something happens on the regulatory environment. Something has to happen. Or it'll just blow up, like all things that grow really fast and uncontrolled. It'll blow up. The problem with that is that a lot of customers are going to find out that they don't know who to talk to. They don't have anyone to talk to. It's going to be a reminder, and we've had different times like this in our past. It'll be a reminder to customers that relationships really matter. They really do matter. We'll be there to help pick up the pieces when that happens, but it will happen. It absolutely will in this case.
Where is the traditional banking system winning business right now? Whether it's Zions, whether it's Europea, is relative to private credit, where is the advantage that the banks have?
No, it's a great question. I think the advantage we've always had has been on the relationship side. That's our advantage at Zions. You'd have no way of knowing that other than looking at external surveying. It sounds like corporate speak, but if you look at Greenwich Research, which is the gold standard for measuring how business customers feel about their banks in the United States, they survey 500 banks, 25,000 surveys. Only three other banks, in addition to us, have received their scores of national distinction, national recognition, as much as we have over the last 16 years. Two of the things that they measure is a bank that values relationships and a bank that you can trust. We have in our investor deck our scores on that relative to the global banks. The global banks are terrific: JP Morgan, BofA, Wells, and U.S. Bank.
They're just terrific banks, great people. Customers just think very differently about us. Where we compete, I think relationship matters, product matters, technology matters, price matters, et cetera, but relationship still matters. The fintechs, they're not really, they don't really penetrate what we do. They penetrate consumer. They penetrate micro business, but they're not really a player in what we do. I think this, you mentioned private credit. Credit unions is another place that it's just inherently unfair. Credit unions, anybody can join any credit union on the planet. You don't have to have this general association anymore, practically speaking. They have this tax advantage. They're going into commercial lending, into real estate lending. They're going into all the traditional bank businesses. The reporting and the transparency on credit unions, again, wonderful people, I'm sure, but it's just totally different.
It is a, talk about an unfair playing field. When you talk about where do banks win, credit unions, they are alive and well, and they are tough competitors where they exist. I just would submit, like private credit, that we really need some legislative and regulatory oversight of what is this industry and why has it continued to be given a tax break.
Got it. Excellent. I want to pivot over to what you're seeing on the deposit side. Zions has seen five quarters of NIM expansion. A lot of that has been driven by success on lowering deposit costs. Can you talk a little bit more about what's driving that?
On the deposit side?
Correct.
Yeah. One of the, we start with a really strong deposit franchise. And, you know, our total cost of deposits is among the lowest of our peers. Even after Silicon Valley, it is still among the lowest of our peers. Part of that is because our demand deposit, our non-interest-bearing deposit to total deposit ratio, has been peer-leading, industry-leading for decades. That strong non-interest-bearing balance franchise that we have is, you know, contributes to this overall lower cost of deposits. We have not lost that. The mix, even though rates have changed dramatically, you can go back 30 years, and our mix in that ratio is as strong today as it has always been relative to peers. I think that helps.
The other thing that we saw, we basically said leading up to the rate cuts in the fall that our beta coming down would look a lot like our beta going up. Our beta going up was 40% overall, 60% on interest-bearing. We are seeing that coming down, particularly of our highest price deposits. There is about $15 billion in these larger, highest price deposits. We had about 100% beta coming down from the three rate declines. That was not accidental. It actually took a lot of work to make sure that when rates changed, we lowered our rates. We did on that $15 billion that you can think of, and pretty much market rates are a little bit less. We are committed to, as rate declines continue, bringing that down instantly.
We, among those highest price deposits, we have a lot of opportunity to continue to kind of trim what we're actually paying without losing those deposits because they're all related, virtually all related to our existing commercial and private banking relationships.
Is there more room for the overall portfolio cost to come down if rates do not go down further?
Yes, I think there is on deposit costs. Yes. First of all, growth will help bring it down. Secondly, the fact that our demand deposits, you know, at the end of the first quarter, you know, had been declining, like all banks in the entire industry. We are about $25 billion right now. And they were down a little bit in the first quarter, but it looked like they were stabilizing. To the extent we have that stabilization, then I think the overall cost of deposits will have some further declines that they can go through. We also have some latency in our time deposits, so that is a smaller impact, but as that time deposit portfolio that we have, which is principally consumer, rolls over, we will see some incremental benefit from that too.
Got it. As you think about NII, you've spoken about seeing NII growth even with rate cuts and flattish loan growth. Can you talk about some of the inherent tailwinds that you have on the asset side of the balance sheet that drive that?
Yeah. You know, basically, you can see our NII disclosures, and we're basically, you know, assuming the forward curve at the end of March, it calls for about 4.5% NII growth. It's coming largely from repositioning in our securities portfolio. We have about $750 million of cash flow coming off our securities portfolio each quarter, and about half of that, we're repurchasing securities at higher rates, and the other half will probably pay down broker deposits or support loan growth. That's probably the biggest element that will impact that growth. We do have some continued loan yield latency that is a positive in repricing. That, and then again, this DDA stabilization, those are probably the three biggest drivers of that growth.
You spoke about the latent sensitivity of the balance sheet. How are you thinking about the overall asset sensitivity of the book as you think about the next few years? The balance sheet is more asset sensitive right now. Are you thinking about bringing that down to neutral over time, or how do you think about that?
That's a great question. We try, you know, ultimately we try to keep the balance sheet pretty balanced, I mean, in the sense of asset sensitivity. We would try to probably have a little less asset sensitivity than we do today. There is a trade-off. If we have higher rates, long-term rates, then we produce a little more AOCI, but we also, if we're asset sensitive, we have more income to offset that. On the downside, there's a little bit of risk there, but I don't think so. I don't think so right now. We basically have this projection for asset sensitivity, and I think it'll play out just fine.
Got it. All right. Perfect. Maybe talk a little bit more about the fee side of the business. Where are you prioritizing investments on that front, you know, whether it's in treasury management, card, mortgage?
Right. So we've got about $635 million in fees that, and it's a great collection of businesses. Treasury management is about a third, about 30% of our fee income comes from the operating services we provide to businesses. It's the workhorse of our fee income engine, and it's nationally recognized. Again, Greenwich Research has given us national distinction in our treasury services. It's great when your workhorse, which is so critical to your primary client base, is nationally recognized. It's a business that should grow kind of mid-single digit, low single digit. We always grow a little faster than the industry is growing, almost always. That core workhorse, you know, is in great shape and is important to our growth.
We then have a collection of other businesses like card, retail business service charges, lending fees that have had some softness in the last couple of years. They are actually showing kind of some low single digit growth rates. Some will, you know, will probably migrate into mid-single digit growth. We have some growth activities like our capital markets business, which we have invested a lot of money in. It is growing great. We were at about $70 million a couple of years ago in revenue. We were at $107 million last year. It is just a great collection of capital markets activities, interest rate hedging, foreign exchange, syndications, bond underwriting. We have a commercial real estate capital markets business that has a lot of upside from a revenue standpoint.
That $107 million of revenue, what we basically said is that we think it is going to be high growth, and it has been. It should continue to provide some nice positive energy. The other two things, wealth is that way too. Our wealth business, the revenue has flattened a little bit, but it is a huge opportunity for us, and we have got great leadership there. You know, I think that will kick in. The other place is our mortgage business. We have shifted from held for investment to held for sale. When you do that, it just drives a lot more fee income. I think where mortgage fees have not been a great driver of fees for us in the past, you will see a real positive influence there.
I think this small business lending activity, even though the numbers aren't big, it actually could have a disproportional impact on overall fee income growth. I'm actually pretty forward-leaning and positive about our fee income outlook.
All right. Perfect. Just talking about maybe credit, you noted that there's still some level of uncertainty for small businesses. Are there any specific sectors that you're looking at where you're seeing a higher level of stress? You know, anything to call out on the credit side?
I think overall, you know, our credit performance in terms of net charge-offs has been outstanding for 15 plus years and more even before the Great Recession. You know, we run at about 10 basis points in net charge-off ratio, and most of our peers run at 20-40 basis points. It is a big strength. A lot of it has to do with underwriting. Most of our underwriting is secured. As investors think about going into a recession, the first thing people think about is consumer unsecured going into a recession. That is not us. We have got about $400 million of consumer unsecured. Not us. If you look at our business portfolios, look at 2008, they performed great. They performed great in 2020.
You look at our small and medium-sized business, C&I portfolios have performed great in two real shock systems, shock moments. Our one to four family mortgage book also has performed well. CRE, a lot of focus on that. We saw classifieds go up last year. We said in January, we thought they'd flatten out. At the end of the first quarter, they were up a little bit, classifieds, but not much. I think what investors should look at there, though, Manon, is that while classifieds have gone up, non-performers have stayed low. They've not gone, that's really untraditional. Most previous cycles would not show that.
That is what drives the losses.
Exactly. You know, the losses we've had on commercial real estate have been negligible by any measure, negligible, even during this period of rising classifieds. We actually, there's a lot to play out with real estate, but I think we're well reserved. We understand the portfolio. If there was, given how long that cycle's been going, the deterioration in CRE, if it was going to produce losses, it would have started to produce it by now. I mean, we're two and a half years into that. You would have seen non-performers build if the loss content was there.
All right. Perfect. We're almost out of time. You know, I'll wrap up with a question on capital. There's a lot of volatility on the long end of the curve. How are you thinking about managing capital? Is there a CET1 ratio, including AOCI, that you're managing through here?
Yeah. You know, for most investors and analysts, CET1 has kind of been the most important measure that most people look at and understand. Now CET1, less, minus AOCI. On that, we screen lower than most of our peers. That is why we are really transparent about how this AOCI mark that we have accretes back into capital. You will, most analysts can look at it and go, okay, over a four-year period here, three, four-year period, you will see that AOCI accrete. We report on it every quarter. It had not changed hardly at all from our original projections. Capital improves to where, you know, the original Basel endgame kind of compliance date was June of 2028. Any investor analyst projection would have us well above, on CET1 minus AOCI, well above any requirements with buffers and more buffers, and we are in good shape.
You have the earnings accretion as well.
No, exactly. That's exactly right. I think, and I think most investors understand our capital ratio, and I think our regulators do and the rating agencies do, too.
All right. Perfect. With that, we're out of time. Scott McLean, thank you so much for joining us.
Manan, thank you very much.