pricing of our deposits. With the March volatility, that certainly, you know, made that strategy that we had stated even more important. You know, the other side of that, though, is that that approach to more aggressive pricing certainly has an impact on the net interest margin. Recall that in our April earnings call, we said that the net interest income would be down about 7% in the second quarter from the first quarter. At March 31st, our spot NIM was 3%. What we're now saying, having seen two months of the quarter, is that we think our NIM for the second quarter average will be about 2.85 for the average for the quarter.
Deposit costs right now, interest-bearing, at 3/31, were 1.63%, spot, cost of interest-bearing deposits. At May 31st, they were 2.43%. The total cost of deposits, spot cost at May 31st, was about 1.4%, up from 0.9% at spot at 3/31. Those are the basic fundamental changes, and that caused us to reduce our guidance from moderately decreasing to decreasing.
All right. Perfect. You know, maybe to dig down a little bit there, you know, you noted in the deck that there could be fluctuations in the mix of NIB deposits. You know, can you speak to how you're thinking about the mix shift between NIB and IB? I think it was at 45, 55 at the end of Q1. Maybe you could dig in a little bit on that.
Yeah. You know, the mix of non-interest-bearing to total deposits, we've been an industry leader in that regard for decades. It's not accidental. It is related totally to our strategy and our focus on banking small and medium-sized businesses. This outsized non-interest-bearing tradition that we have is a function of many small operating accounts for these businesses. They generally are not as rate sensitive because these small and medium-sized business owners are, they're more focused on their top line than making an extra, you know, 50 basis points on a $50,000 balance or a $75,000 balance.
Even if you go back into the 2008 timeframe and before, we've been top quartile and generally top of the charts when it comes to the mix. It's difficult to know where that percentage will change. We're in the mid-40s right now. We were as high as 50, low 50s, which is really strange, quite frankly, when you think about our industry. It's certainly come down and will be influenced by the higher pricing that we're doing. The one thing we're really confident of is, just like in the previous decades, the basic tenets of that deposit base are the same. They're the same type of customers, same type of operating accounts when it comes to non-interest-bearing balances.
If rates continue to go up or there continues to be a shift, we think we will continue to maintain this competitive advantage of the percentage of non-interest-bearing balances to total as we have historically.
you know, one of the questions I get is, you know, people look back to 4Q19, sometimes look back to pre-crisis. You know, you have a great chart in your deck showing the NIB% over a long period of time.
Right.
you know, do you think that the 2008 mix of 25% of NIB is a reasonable baseline, or do you think it's hard to get there given where you're starting from right now?
A lot's happened since 2008, and in 2008, you know, our mix was in the mid to high 20s. Our peers, most of our peers were in the high teens, low 20s, so that competitive advantage was there. I don't think it could get back to that level simply because we've had two serious quantitative easings, maybe even three, depending on, you know, how you measure it. But when you think about all the cash the Fed put into the industry and into the markets following 2008, and then again in 2020, with some, you know, liberal support throughout that decade, really, I think, pretty difficult to get back to a percentage that is that low.
you know, as we think about the, the deposit mix between NIB, IB, brokered deposits, the sources of funding, I think you put on about $5 billion or so of brokered deposits.
Mm-hmm
in 1Q. You know, how are you thinking about that mix as we get into the rest of the year?
Yeah. 1Q was an interesting quarter. I mean, it was a pretty normal quarter for two months, then the volatility in March was interesting for everybody. You saw that increase in brokered deposits. I would think most investors, as they watch us go through this cycle, will appreciate the flexibility we're showing, both in terms of how we're creating this funding, but the cost of it. Brokered deposits was certainly one lever we could pull. Reciprocal deposits is another lever we can pull. Both of those, along with just our higher rate sweep accounts for large clients, that all three of those will ebb and flow and they all provide a very stable source of funding, number one.
Secondly, they give us an opportunity to trim costs off of just wholesale borrowings, overnight wholesale borrowings. It's both, those three types of accounts, allow us to manage that overall cost.
Mm-hmm
better because those are lower cost options generally. They, you know, ensure that we're always having the stable funding we've always had.
Perfect. you know, maybe to just summarize the decline to 2.85% in NIM in 2Q 2023, primarily driven by deposit costs and a little bit by the mix shift as well, but primarily as you get more competitive on the deposit side.
Right, that's an average for the quarter.
Correct.
285.
Okay.
Yep.
I guess as we think about deposit betas, I think you're about 27% all in, you mentioned in the deck. You know, how you noted that the cost of deposits is up to about 1.4%?
Mm-hmm.
How should we think about through the cycle betas from here?
You know, deposit betas is a, I think it's a really interesting topic for analysts and for some really sophisticated investors. I think most investors, particularly long-term investors, look past betas and look at what's the real underlying source of deposits? That would just take me back to the comments I made about this orientation to banking small and medium-sized businesses, and what an advantage that has been for us over the decades. As for where betas might go, they probably will go up.
Mm-hmm.
It just depends entirely on the interest rate environment. Everybody's going to have to make their own assumptions about that. The one thing that investors know about us, though, is that you go back to periods of rate increases, interest rate increases, that most people would think about, in almost every one of those, our beta was less than our peers.
Mm-hmm.
The period of time it increased and the ultimate beta was always very competitive to our peers. This gets back to this client base that we have.
Yes. I guess the granular deposit base helps you on a competitive level versus-
That
other banks.
That-
I mean, Man, that's one of the things that we've shown in the slide two, where we go back 20+ years and say, "What's been our competitive advantage, and how much has it been?" We said anything above when Fed Funds is above 3%, what has been the cost of deposits advantage for Zions? It's been about 40 basis points. Whether you look at cost of funds or cost of deposits, it doesn't matter. It's about 40 basis points. Can't say that it would be speculative to say that it'll still be 40 basis points going forward because things change, right? Technology changes. That allows people to move money faster, and seek the best rate.
At the end of the day, to Scott's point, most of these small businesses that we bank, and there's over 200,000 of those, are not worried about getting an extra 10 or 20 or 30 basis points. They're worried about the relationship they have with their banker. Scott's got some cool data on the desire for small businesses to have a relationship and to have a branch. It's actually pretty cool data. That's what they care about. It's not that extra 10 or 20 basis points.
maybe you can talk about that. You know, the deposit base is fairly granular. We're also, you know, now three months since the bank failures, rates are at 5%. I mean, how much low-hanging fruit is actually there for deposits to move out of NIB into IB or these IB deposits to reprice?
Yeah, it's, again, it's hard to say. Depends on what happens with interest rates. Our non-interest-bearing balances, again, have just shown much greater resiliency than that of our peers, and we don't have any reason to believe that will be different this time. What we do think we'll see, given what we communicated in our January and April earnings call, is that our customers, you know, by and large, are happy to have their funds on our balance sheet. We went through the 2020 and 2021 time period, because the industry was awash with deposits, our deposits were up 35% in that two-year period. The industry was up about 30%. We were encouraging customers to move their deposits off balance sheet.
We had, at one point in time, $12 billion of client deposits off balance sheet in sweeps. Things changed in 2022 and early 2023, we're bringing those back on.
Mm-hmm.
When you talk about the change in interest-bearing deposits, I think given our strategy and the relationships with our customers, you'll see deposits being stable, certainly relative to the March timeframe, and growing as they come back on balance sheet. The cost will be higher than what we paid before, but it will be less, should be less than overnight borrowing.
All right. Perfect. And I do want to get into the asset side and, you know, how you're managing the securities as well. Maybe just the last question on the NIM. You know, as we think about NIM being at about 2.85 average for the quarter for 2Q, how should we think about NIM going forward as it relates to your guide for decreasing NII going into 1Q 2024?
Right. you know, in the April earnings call was that net interest income would be down about 7%. that was a, you know, it was a one-quarter view that would lead into, you know, a 12-month view. That's where the moderately decreasing was coming from. I think most people would interpret our use of the word decreasing as it relates to net interest income. I'll let you back into the NIM, would be a percentage at about that level, or maybe even higher over this next 12 months. Again, depending on the, you know, what happens with interest rates.
Maybe the other side of that is the earning assets. you know, loans are a big part of that. As we talk to other banks, a lot of banks are scaling back a little bit on loan growth, tightening lending standards. Can you talk about what you're doing in this environment?
Sure. We saw about 3% loan growth in the first quarter, and we're not giving any guidance on that in the second quarter. We're coming off of 5 really terrific quarters of loan growth. The five quarters before that were over the pandemic period, and loans were pretty flat during that period of time. We've had five really strong quarters, it's going to moderate from that, and we think that's appropriate given the increase in interest rates and the possibility of a recession. You pick what kind of recession. Investors should expect, and we should expect loan growth to moderate. You particularly see that when you think about commercial real estate lending, that's going to be soft for the industry. We have...
You know, our commercial real estate portfolio is pretty much flat in absolute dollar to where it was in 2008. We've shown a lot of discipline on CRE, where most of our peers have actually had pretty significant increases in CRE over this period of time. That's going to be soft. One to four family mortgage has been a good balance creator for us, and that certainly has softened in the economy. I think some of the natural drivers of loan demand, and then C&I is the biggest part for us, is 50%.
I think business owners. They're in a watchful state right now, whereas the previous five quarters coming out of the pandemic, they were happy to get back to work and, you know, get in a forward-leaning mode.
What does that. It sounds like it's more a function of demand rather than supply across the industry. Do you think standards also tighten as we go forward, given the higher cost of funds?
I think we maintain really high standards throughout all periods, but as rates have gone up so quickly, you would naturally adjust your underwriting. As you think you're going into a recession, you would naturally update your underwriting. I think going into a recession, just kind of big picture, I think most people are worried primarily about initially, consumer unsecured. That's kind of the first thing that goes bump in a recession, usually. We don't have very much consumer unsecured. We're not the consumer unsecured bank, okay? A lot of people would look at construction lending, we have about $2 billion in construction loans. It's less than 20% of our commercial real estate loans.
80% of our about $12.9 billion in commercial real estate is in term loans. Anyway, we don't have a lot of construction. We have virtually no land loans, about $200 million in land loans, which, you know, compares to $3 billion in 2008. Virtually no land. Those are all categories that most investors would look at and express concern about, in addition to leveraged lending, which I think Moody's is going to put out a report here fairly soon, sometime later in the year, as they did a few years back. I think most investors will see that we've been conservative on the leveraged lending front as well. The, the major areas where you would be concerned, I think we screen really well and our underwriting.
We're not having to make a lot of underwriting changes in those, in those regards.
I do want to touch on credit, but maybe before that, just to round out the conversation on the balance sheet. How should we think about the securities book? You know, it feels like that the duration on the deposit side is moving lower, there's a potential for more regulation as well across the entire regional bank space. How do you think about that, and how does that inform your view on how you manage your securities book?
The securities book is about $25 billion today. It is virtually all government securities, highly liquid, easy to borrow against if you need to do that. The cash flow out of that portfolio is about $3 billion, + or -, right now, a year, annually. That's, you know, that's coming off at 2% rates, and it's going back in at higher rates. This is part of the asset repricing that I think many investors are not really focused on. They're really focused on the cost of deposits, cost of interest-bearing, net interest-bearing mix. Everyone sort of hadn't really turned their attention to what's happening on the asset side.
We'll see a natural repricing in the securities portfolio, and we'll also see a natural repricing in the loan portfolio, and which we have disclosures about that. But deposit costs are not the only thing changing right now. I was just going to say, Manan, as we think about the size of our securities portfolio, it's several billion dollars higher than what we would normally run, the size of the securities portfolio proportional to the balance sheet. We can probably, at least the current plan, is to allow the securities portfolio to decline several billion dollars, and that will pay down borrowing. It's, you've got money coming off at 2% yield and paying off borrowings that are 5.25%.
That's a huge net interest margin or net interest income expansion sort of situation. Loan yields, I mean, I think everybody knows where the Fed funds rate is today. Our loan yield was only 5 basis points higher than Fed funds. If you think about that in the first quarter, that's not where we book loans. We don't book loans at Fed funds + 5 basis points. It's closer to about an 8% yield on loans. It's probably 7.75 or give or take. The whole loan portfolio will reset substantially higher over the course of the next several quarters. The deposit situation has been a hurry-up sort of situation, and that's been much more accelerated thanks to the events of March. I think after the ...
There will be a gradual, improvement, over time in that front.
It sounds like just given the pace of the rate hike cycle, the deposits have been catching up a lot faster...
Right.
and you have to reprice securities, you have to reprice. You mentioned over the next several quarters. I think you also mentioned about $3 billion or so is running off annually from the securities book.
Right.
How do you think about, you know, reallocating that back to securities versus allowing?
Well, I think James said it. We have the option to either buy securities at higher yields and similar duration, we're not changing our duration outlook, really, or to pay down overnight borrowings, which are, you know, basically the Fed funds rate.
Got it. Okay, perfect. Just as you think about regulation, you know, there's increasing conversations on regulations increasing for mid-sized banks. How are you thinking about that? What are you hearing from regulators?
It's really hard to speculate. We have a very close relationship with our regulator, and it's, you know, impossible to know what exactly they'll do and what the overlay will be. I will say, though, that if you think back, we were the smallest of the SIFIs when SIFIs were a thing, back in the 2008 to, you know, 2012, 2013 time period. We've, we're pretty battle-tested on the large bank regulatory regimes and risk management practices. That's something we actually, you know, well, it's not really a new thing because we never stopped doing it. As it comes to capital, though, I think this is a pretty misunderstood concept right now. You know, our regulatory capital, Common Equity Tier 1 at about 9.9%.
We're well capitalized based on the regulatory regime that exists today. Been a lot of focus on tangible common Which is less AOCI, it's less marks to the loan portfolio, et cetera. I understand why people are focused on that. If you look at, to your question about regulation, if you look at the regulatory capital ratios that the global banks have, it's basically CET1 minus AOCI. Okay. On that basis, we're at 5.5% today, and if you assume there's going to be some phase-in period, which hard to imagine there wouldn't be, over, let's say, three years, you can do the math with the disclosures we've made on AOCI accretion and earnings and any kind of recession overlay over a three year period.
I think most analysts will conclude that the growth in our regulatory capital on that more rigorous global bank basis, will be well in excess of, the well-capitalized construct that the, that the regulators have.
It sounds like the regulators have made it pretty clear in their reports, as well as in their testimony, that there will be a long phase-in period for any regulations that come in.
It doesn't even need to be real long. I mean, literally, if you just use three years of AOCI accretion and any conservative earnings accretion you want to think about with maintaining the dividend, you're going to see that our regulatory capital, based on the global bank formula, is well in excess of what the regulators call well capitalized.
Perfect. I'm going to go to the audience for a quick question or two before we have to wrap up by 8:00 A.M. Just to round out that conversation on capital, you mentioned pausing buybacks and earnings. It's pretty consistent with what the other banks have done. Can you talk through that decision and how you're thinking about capital return in this environment?
We're always thinking about capital and the return on capital. It's a terribly important concept. And we've had significant buybacks over the recent years, we've shown a willingness to trim. We always want to maintain our capital, though. We've said this for quite some time, at or above peer average, okay? You'll see us continue to do that. In this period, it's just logical that we would pause buybacks and in that environment, you're going to see us accrete capital at, I think, at a nice pace.
All right. Perfect. Are there any questions in the room? One up front.
If no one's asking, I'll just keep asking questions. Do you think we're I'm a credit investor, but do you think given where the equity is trading, that the goal is to just merely show that you're a strong bank, you can build capital and watch the revaluation of the equity in the capital stack, as opposed to hurrying to do a capital return?
That's a great question. That's really what I'm trying to say, is that if you even if you look at us more conservatively with the global bank capital requirements, and you look at any phase-in period that's not very long, you'll see us accrete capital to where we're well in excess of well-capitalized. There, to your point, there's no hurry to do anything other than just stay really close to fundamentals.
I'll ask you what I think is a fairly straightforward question. In the past, you know, you have been, I guess, beholden to the Fed and the FDIC through. Do you have more constituents now that you have to keep happy in terms of your balance sheet?
I'm not sure exactly what you mean by beholden to the Fed or the FDIC.
Well-
I would just-
You march to their tune, right?
Well, we march to everybody's tune. We principally march to our investors' tunes.
Equity investors-
And-
Credit investors?
equity investors.
Okay. Do you have to march to credit investors now and depositors?
Well, let me just. I appreciate the question. I think that there's no one approach that ever works, okay? We have to, through the cycle, stay focused on equity investors. We have to stay focused on those that have more of a credit perspective, because you have to manage credit well, which we have absolutely done through many cycles. You can go back many years and see our credit quality stats screen very well against our peers, and we're coming off a period of, you know, almost zero.
Charge-offs.
Yeah, almost zero charge-offs. Whether it's equity or folks that are more focused on credit or regulators or customers or communities, we have a whole many dimensions that we have to balance.
All right.
Thank you for those questions.
Maybe in the last minute or so we have here, can you talk about, you know, with all the noise since March, you know, what part of the Zions story are investors missing?
Thank you. Yeah, I think first is this capital question. Will we need to raise capital? Again, I think anyone that does the math will come to the conclusion that no, Zions does not need to raise capital. I think there's clearly a discount in our stock related to that. At some point, investors have to decide, "Okay, we can see that, and that discount should go away." Second thing is on deposit costs and asset repricing. We've tried to provide a lot of disclosure on that, and I think folks can model that. This fundamental relationship, competitive advantage of our non-interest-bearing mix, again, it's not accidental. It is core to who we are.
Risk management, I think, is the third area, and that's one where we've kind of needed some downturns to really demonstrate that fully. I think investors will see, particularly through the ways that I described, being very conservative about commercial real estate, repositioning our loan portfolio since 2008 in a dramatic way, and approaching loan growth responsibly. I think they're going to see our risk management practices are really strong. Finally, so much of the value, you know, a lot of the value in our company is this deposit franchise. I think folks will see that, through different rate cycles, as it has in the past, it will stay a competitive advantage from a valuation standpoint.
All right, perfect. With that, we're out of time. Scott McLean-
Great.
Thanks so much for joining us.
Thank you, Manan.