Continue. Next up, very pleased to have Zions Bancorporation from the company, Harris Simmons up here, Shannon Drage from Investor Relations. I know Harris put out a slide deck on Monday. I don't think you're going to take is us through that, or just want to jump into Q&A?
We'll probably jump into Q&A. I think we had, I mean, it was the same, fundamentally the same disclosure we'd had at the end of the second quarter, with the exception of a slide where we provided some kind of contemporaneous information on deposit trends and pricing and NIM. Which I think everybody's probably found helpful, but I'm guessing a lot of people here have probably seen that, and I think we can.
Yeah.
Jump right in.
Jump right in. We'll get to that. I think it was page 19 jumped out to me. But I guess maybe we just start, big picture, before we kind of get into the financials. You know, obviously, you know, franchise that's, you know, situated in the western part of the country, you know, very kind of small business market focused. Maybe just talk to kind of what you're hearing from your customers, given this high inflation, high interest rate, uncertain economic backdrop.
Well, I think, you know, if I go back a few months, I mean, maybe what's changing is what I think we were maybe hearing predominantly was a really tough environment in terms of finding labor. I mean, just good, good help was hard to find, and everybody was seeing it in higher turnover and pressure on wages, and I think that's really changing. It's probably I mean, it's still, I think, labor market conditions still reasonably tight in the markets we're in, but certainly better than they've been. You know, we're seeing a real slowdown on loan demand. I suspect that's kind of a function of just higher rates.
I mean, it's just, we've got a lot of people running businesses that haven't, that have never had to carry inventory or, finance assets at, you know, borrowing costs that, that might be 6% or 7% or 8% for small business. And anyway, so, loan demand has slowed, but it things continue to feel pretty healthy, and certainly it's, you know, reflected in credit quality and, and, and delinquencies and small business credits and middle market, still looking really good.
I guess when you think about that segment, you know, there's a chance we could be in this high interest rate environment for a while. At some point, do they just need to kind of borrow despite the fact that costs are elevated? Or kind of how long does this kind of, you know, slow down last, you know, in loan demand, assuming kind of an, you know, kind of economy muddling along, albeit with high rates?
Well, you know, I don't know. I think if you put things in historical perspective, the rates we're seeing today are actually kind of the norm over the last 40 years. I mean, it was the last 10 years that was kind of the aberration. And so, I just my own supposition is that you know, people ultimately kind of adjust to the idea that this part of the cost of doing business is financing inventory and expansion and going up. But, you know, it's going to be helpful to get beyond sort of this overhang psychologically of, is a recession around the corner? And so, you know, and that's been kind of like the mechanical rabbit at the dog races.
I mean, it's always just kind of 20 yards in front of us. It'd be nice to have it 20 yards behind us.
It always seems to be looking out. You know, you kind of referenced kind of a slide deck, which you did show kind of monthly deposit trends. And you know, one of the things that we you know saw is, you know, clearly kind of you did see deposit you know kind of growth with June to July to August, after kind of a you know measured decline kind of earlier in the year. Can we talk to in terms of you know where is that growth coming? Is it kind of customers that diversified coming back? Is it new customers? Is it you know customers that are growing? And just maybe talk about your expectations around mix.
I might, and I have Shannon, she's done a lot of research into it. Just talk a little about that.
Sure. Yeah. On the deposit side, what we're seeing here in the third quarter is sort of a continuation of our efforts that we started much earlier in the year to bring some of our customers who had moved off balance sheet, you know, for rate and, and to bring them on balance sheet. So they're, they're coming back onto the balance sheet in competitively priced products. We are seeing some return of customers who maybe left when tensions were high. And certainly some new customers. With more competitive pricing, we are seeing some new customer growth there.
And then in terms of, you know, the shift out of non-interest bearing into interest bearing kind of persists, I mean, I guess any signs of that abating and just how do you think that plays out, you know, for in the near to intermediate term?
Well, yeah, it's the, I mean, the if you were to kind of graph the change, it's the slope is settling out, and I expect it will continue. I don't know where the kind of terminal value is going to be. You know, back in If I go back pre-financial crisis, which was such kind of a similar rate environment, if you get back to about 2006, it's going back a ways... But it was at 25%, demand deposits, total deposits. I you know, today we're at about 37, and I don't think it goes as low as it was then.
And, you know, unless we see quite a lot of additional hiking in rates, but it'll probably continue. It's a little like, you know, there's kind of low-hanging fruit or, you know, a lot of the obvious excess balances money, rate sensitive money and demand deposits has left. And, you know, it will continue, but I think at a diminishing pace. But I'm not quite sure when it, you know, when it settles out, probably when rates kind of peak and start come back down.
And then you guys were, I guess, active users of broker deposits over the last few quarters. Assuming you kind of begin to roll those off, or how, how do you think about that?
Yeah, those. I mean, it was opportunistic, right, you know, in the wake of what happened at SVB. You know, you're just grabbing anything you could off the shelf, to, to make sure you had a lot of, yeah, liquidity. And, and it, it is running down. It peaked about $8.5 billion, it's coming down. I would expect that that will continue, you know, to, to run off as we kind of normalize and, and have, both bring, some of the balances that during the surge in deposits, we kind of pushed off the balance sheet, bringing them on, and other customers coming back. So that'll, that'll come down to a much lower number.
Last, I guess, just given the improved deposit growth outlook, does that kind of play into all your kind of expectations and kind of where betas pan out for the cycle?
Yeah, again, in terms of betas, I mean, the Fed is slowing. They may be approaching something of a peak, and I would expect that that's kind of where, you know, you know, you'll see the same with betas. You know, again, I'm not, you know, I don't know where the terminal number is, but it feels like we're probably getting there. In terms of deposit growth, you know, I expect that this quarter will be another good, you know, this be a good quarter for deposit growth as we continue to kind of rearrange the mix and bring some off-balance sheet money back on.
And beyond that, you know, I mean, deposits have really driven the growth in recent years. But even before the crisis in March, as the Fed started tightening, I mean, deposits were coming down and the Fed had flooded the industry with money, started to pull back, and we were seeing that. I mean, Silicon Valley really accelerated that. But you know, what I would expect to see going forward is that, you know, we're seeing weak loan demand, securities that probably will run off a little faster than incremental loan growth.
I think that'll probably actually kind of put a cap or even, you know, we could see a little smaller balance sheet going forward.
Got it. Well, we're going to come back to that in a second. I guess the, you know, drop in NIM from, you know, January to May was, I think, greater than a lot of us would have anticipated. On the flip side, now, you know, the improvement from May to August, you know, has been, you know, kind of outperformed peers. Maybe talk to, you know, maybe some of the drivers of that and just how you kind of see that trajectory going, you know, into the end of this year, into next.
Yeah, well, I mean, so there are a couple of drivers to it. First of all, we do have a lot of asset repricing going on. As we've been bringing money back onto the balance sheet, it's been displacing higher cost wholesale kind of short-term borrowing that we put in place, including even some of the broker deposits right in the wake of SVB. And so all of that's playing out into a little stronger NIM. I don't know if you have any other thoughts about it, Shannon, in terms of what's any of the elements, but I think those are the major ones.
Yeah, I mean, I think you saw us have, you know, a pretty significant gap in terms of deposit-total deposit costs to peers prior to SVB. I think you've seen a lot of catch up there, where we're kind of back to more of a historical norm relative to peers. So I think that when you're looking at kind of that, the drop, you know, we did have some catching up to do on the deposit cost side.
Got it. And then maybe on the expense front, one of the themes from this conference is third quarter expense is running higher than expected, which is a little bit surprising because you would have thought March, April events would have made people tighten up a bit. I guess there's other pressures and, you know, on the flip side, though, everyone's kind of talking about better expense management next year, although I think we heard that last year and not happening. But just maybe talk about, you know, just overall expense management as you kind of begin the 2024 budget process.
Yeah, you know, well, we've been trimming headcount. I expect that we'll start into the year, a lot of this is actually in place as we speak. We'll come into the new year with about, you know, at about 3% reduction from from where we were in the first quarter. And, you know, we're everybody I, you know, I talked to our peers, you know, everybody's looking for ways to, to cut costs.
One of the things I would note, it's not to pin the tail on this, but I mean, the regulatory environment is a really tough one right now, in terms of what is being asked of banks, in terms of just resilience and controls and, you know, a lot of that was in place before SVB, but that's exacerbated it. And so, you know, I look at our spend. I mean, many of you who follow us know that we've been spending on quite a lot to, you know, replacing core systems.
But, you know, beyond that, a lot of the spend is really dealing with just really strengthening and, you know, fortifying the operational resilience of the organization. And a lot of that's driven by a regulatory agenda, which I think you're seeing around the industry. And it's not something you can kind of just say, "Hey, we'll put that off." That's not an option. So that's driving some of the spending pressure, I think, with us and in the industry.
Got it. Then, merely on credit quality, your, you know, losses have kind of been nonexistent. Yet every day I pick up the paper, there's all this kind of concern on commercial real estate and office and, maybe kind of just update us in terms of kind of what you're seeing, hearing from your customers from a credit perspective. You know, where you're kind of most concerned about and, and maybe why we haven't seen kind of losses manifest themselves yet.
Yeah, I mean, I, I, the only, the only area I mean, you're concerned about everything in an environment where, you know, as you see the economy slow, potentially. The, the, the office segment, commercial real estate, is about a $2.2 billion portfolio for us. And it's one that I, I mean, first of all, I back off and say commercial real estate, for the last decade, you know, really coming out of financial crisis, you know, there are things you learn and say, "Okay, we're gonna, we're gonna do something differently." And, I think one of the things we learned, underwriting, as we came into the financial crisis, was actually, I think, was actually quite good. I think we've done that well for a long time. Concentration management wasn't.
We said we got, you know, we had way too much concentration of construction, land development in places like Southern Nevada and Arizona, and places that had some real challenges during the crisis. We came out of it and said the mantra was that commercial real estate is going to grow more slowly than the rest of the balance sheet. That translated into some limits and some discipline that's actually growing. I mean, if you look among our peer group, I think you'd find that we're maybe in the bottom decile or so in terms of CRE growth. Over the last decade, it's grown at a rate of a little under 3% compounded.
We used to be, you know, quite outsized, but I think we're back to approaching something closer to kind of the norm in the industry. If you're going to be in the West, real estate is going to be part of your game. I do think that we have the benefit of having sort of a lot of kind of vintage diversity in the portfolio, and that brings with it amortization. I think we have a really good underwriting culture in the company. On the office segment, it's about a $2.2 billion portfolio. At present, I mean, if you go through it, I've gone through it name by name for at least the largest exposures.
There's actually amazing strength in most—I mean, there are a handful of names where we're, you know, really watching it carefully. But nonaccruals in that portfolio are about $16 million today. Criticized classified in the portfolio is under 5%. And it's not something that's really keeping us away. We got deals, and some of the largest deals—I was reading a list of, you know, among the 25 largest deals, just going through LTVs, loan to values on... You know, it's based on the latest appraisal, and that may have been a while ago, so with a grain of salt. But we got numbers in there like 20%, 6%, 11%. You know, there's 60%, 70, 40, 23.
It's not like everything is marching to the hilt. There's really quite a lot of an d so there's really quite a lot of strength in most of the portfolio. And then there are some names where they're repositioning an asset, you know, taking something down to the studs and going to turn it into something else, or you're going to have some negotiation with the borrowers that matures. But so far, just about without exception, I mean, sponsors are supporting our deals. One way, you know, you have maturities. We've got about $436 million that mature this year in that portfolio. And you know, the negotiation is you bring additional cash or, you know, we're gonna raise the rate or...
So it's so far working out, I think, quite well, and I'm not really excessively concerned about it. To the extent I'm concerned about any portfolio, it would be that one. Multifamily is seeing some weakness in some markets. But again, not anything that we're seeing, and it's something that we've kind of, again, I think, had some pretty good discipline around over the last half a dozen years, which is gonna help a lot.
So I mean, I guess we read a lot, it seems like every day in the financial press, there's another article saying, you know, office CRE is the next Armageddon. I guess, are those concerns maybe overblown, or is it a major issue, but yet, given kind of your focus on LTVs, you know, maybe an issue as a whole for other banks, but not so much for Zions?
No, I don't. You know, I don't think fundamentally it's overblown. But I think it's, it gets very specific with respect to market, and whether it's urban, suburban, the nature of the strength of the sponsor, et cetera. I mean, one of the really fascinating things about our office portfolio is the median size of a deal, it sounds unbelievable, is $900,000. The average size of a deal is $4.5 million. I mean, there are a lot of... And it kind of reflects the small business, this kind of granular. So I mean, a lot of these deals can kind of, there are ways to work through it.
Just, you know, these aren't 60-story high-rises in downtown L.A. that we're financing, so.
Good point. Good point. You know, there's been a lot of new regulations come out for the industry over the last month or so. I appreciate that you're closer to $90 billion than a $100 billion. But, you know, I guess, you know, do you-how do you kind of think about the Basel III or long-term debt or some of the liquidity stuff coming out? Does that have any impact on you?
Well, I mean, it will. You know, we expect that we'll have probably 4-5 years before it actually will kick in for us. So, you know, others will, it'll be. It'll be phased in. For us, the phase-in will actually be. I mean, it won't be as it'll be more abrupt, but sort of the same, you know, ultimate timetable, sort of. I mean, we're probably out a little further. But yeah, I mean, we will start to prepare for that. You know, the preparation really entails make sure you have data feeds, you got the right data, definitions, et cetera, to meet the requirements. You know, and that's where a lot of the kind of internal heavy lifting happens.
And I think it's gonna be manageable. I mean, it's there'll be, you know, a big project work effort around it, but but doable. I mean, a lot of the work we've been doing on core systems replacement, I think, is actually going to be helpful because we've it's forced us to go clean up a lot of, you know, kind of clean the house and the closets, before you convert some of these big core systems, deposit systems, et cetera. And so I think that that is the groundwork for a lot of what's gonna be needed. I mean, the impact on the capital side, you know, we think it will be, you know, it'll be incremental. I mean, primarily, probably on the operational capital piece.
Not sure of it. I mean, we'll have to see the final proposal and finish the math, but our notion at the moment is that it's not gonna be particularly punitive given the construct of our balance sheet. The operational piece will, yeah, that'll be a new element, and. But, you know, we've managed through it. The debt piece is gonna be, that's just the tax on size, and I think we're fixing a wrong problem, but that's for another day.
I guess we had one bank, another $90 billion or so bank yesterday, make the comment, you know, "We don't wanna, you know, it, it, probably not a good idea to dribble over the $100 billion dollar market, market, but go through it," you know, I forget the exact quote, "with a punch or something." You know, implying, you know, maybe we see more consolidation at the lower end and, you know, you're better off getting, you know, two $90 billion dollar banks together as opposed to, you know, crossing it one afternoon. You know, and I know we've talked a lot about economies of scale in banking in the past. You know, I guess maybe any thoughts around that?
Yeah, I mean, I think I don't agree with the premise of it, and for the following reason: You know, what comes with $100 billion now is gonna be this new capital regime and a long-term debt requirement, fundamentally. I mean, the resolution planning thing is, you know, I don't think that's a huge deal. I mean, it's doable. Once you develop, unless you have an amazing amount of change going on all the time. I mean, once you get the template there, you keep refreshing it. But the capital and the debt pieces are fundamentally gonna be variable costs. And so, yeah, take the debt piece.
It becomes, for most banks, the constraint will be, 6% of risk-weighted assets. So if you're $100 billion and L et's just make it easy. If you've got 100 billion of risk-weighted assets, you know, you're gonna have $6 billion of debt. If you double your size, you're gonna have $12 billion. And so I'm not sure. I, when I think of economies of scale, I think of fixed costs that you can spread over a larger base. This is a variable cost, and the same with the capital charge. I mean, if you have even the operational piece of it, I mean, you double the size of the business and fundamentally your capital is gonna double.
And so, you know, I just don't think that this I mean, there may be other arguments, though, as we've talked about before, I'm not sure. I'm not persuaded that they're all that real. But, I don't see in the capital and the debt piece an economy as a scale argument because they're variable, fundamentally variable costs.
Makes sense. I want to pull up and see if there's questions from the audience. I got scolded in the last presentation that we didn't ask the audience questions, if there's any. I see right, right there.
Thanks very much. With all the weather news coming out of the West this year, too much rain in one area, not enough rain in another, how are you finding both your customers reacting and your own lending practices and policies to adapt to what we shall see, whether it's a fundamental change in the environment or an anomaly this year?
Yeah. Well, first thing I'd say, we had the best snow year we've had in years. If it repeats this year, it will be actually phenomenal. We've, yeah, we've been kind of in a long-term drought. The Hyatt Hotel in downtown Salt Lake City actually had a thermometer thing up the side of the building showing the snow depth, and it went up to almost the seventh floor. They had 900 inches of snow cumulatively up at the. All the skiers were just, so that which created a little bit of localized flooding, but it was fundamentally great. But the better answer to the question is that, yeah, drought, water – the big issue in the West is really water availability.
You read about whether it's the Great Salt Lake, which has been kind of concerned that it would just dry up, Lake Powell, Lake Mead, are way down. And those, those are very real issues. You know, for most, in terms of direct impact on borrowers, I mean, we have an ads portfolio in places like Idaho. It's not a material part of our business, and it's something that you're able to kind of watch year to year. I mean, you know, we're, we're looking at a borrower's water rights, their, you know, seniority, availability, all that goes into the underwriting process. I think the larger issue in the West is water availability. I
My own belief is that, you know, all of the issues about climate change aside, which I personally believe are very real and something we need to be attending to, but it's not something that as an organization, we're going to solve. We need to kind of be responsive to it. But the fact of the matter is that about 70% of the water in the West, in the Intermountain West, at least, is used for agriculture. And in a place like Arizona, over time, as you've converted cotton crops into, you know, into residential neighborhoods, for example, it turns out that people use a lot less water than agriculture does. And so there's fundamentally water supply. It's just how it's used and getting.
You know, I personally have a belief we have to let the market work and sort that out. You have to let those who own the water rights be paid fair market value and sort it out. There's probably too much agriculture in some parts of the West, given the water-intensive nature of it. But, you know, I don't think that's gonna have a lot of direct impact. It will have some, you know, to the extent local governments don't get it sorted out, it you'll have a moratorium on building, and that can, you know, affect population growth, you know, in-migration, housing prices, et cetera. But, I It's not kind of on the top 10 list of what I worry about. Any other questions?
I did have an email question, Harris. But the question was, you know, on your kind of outlook slide for net interest income, you still have stable to slightly decreasing when we think about Q2 2024 versus Q2 2023. But given the trajectory of NII over the last few months, you know, at what point does that switch to kind of, you know, slightly increasing or whatever kind of nomenclature
Yeah, I think we fundamentally I mean, we left the guidance alone. As a general rule, we're not gonna be changing guidance intra-quarter. So we'll have a discussion about it once, you know, when we get third quarter numbers. We'd like to have at least one more data point before we start changing what we said a couple of months ago. So I'm not sure that two additional data points is going to make a trend for us yet. But it, you know, so far so good. I hope it's promising enough that we'll be able to say something more saying one. But, you know, as I said, too, I think the, you know, you've got some countervailing for you.
Yeah, the margin's been improving, but I also think, you know, you're going to have pressure on balance sheet growth, which isn't a bad thing necessarily. It's just right-sizing the balance sheet. You know, balance sheets really grew as you had, you know, deposits in the industry grew by a third over 24 months during the pandemic. And, you know, that's not natural. And so I, you know, I think kind of there's a right sizing that takes place, but that will probably keep earning assets flat to maybe even down a little bit. Even as margins, I hope, continue to improve. So I think we've got a little more sorting out to do before we're going to change the forward guidance on net interest income.
Right. I guess in capital, you know, kind of Tier one ratio continues to look good. I guess with given the kind of the unrealized losses, TCE, you know, maybe a little bit slower than peers. How do you kind of think about that, particularly in a world where you're kind of at some point moving, where kind of this AOCI option goes away for CET1?
Well, it's going to be a reasonable, for better or worse, that our situation will have the, the virtue of reasonable predictability, and that we moved a big portion of the portfolio into HTM back in the fourth quarter of last year and locked that in place. Because I said, like, if Feds out of control, you know, I think we can live with this, with this particular number. And, and so, you know, our forecasting on this suggests that, you know, over the next four years, most of, you know, the lion's share of that, will be gone. And, you know, we'll, you know, we'll have some new rules that will inform kind of the duration and the positioning of securities on the balance sheet.
So, we think it's going to be quite manageable, without really impairing what we're doing with dividends and even some probably moderate kind of buybacks if we perform reasonably well. So, yeah, we're going to have to do some additional math to really understand kind of when the NPR is finalized and we understand the new rule book. But from the broad outlines of what we see so far, we think we'll be in pretty good shape, four years from now when it actually becomes effective for us.
Got it. Any other questions? You know, one thing that I kind of skipped over when I was kind of running through the income statement was the income. I know it's an area you're trying to build out. Maybe you want to provide us some updates and some of the kind of the key initiatives there.
Yeah. Actually, do you want to talk about fee income more?
Yeah. I mean, this is definitely an area we've continued to focus on. We have a couple of, you know, businesses that we're continuing to invest in and grow. One is wealth management, you know, where we feel like we're a little underrepresented there. So we've had some really great growth. We expect to continue to have growth there, kind of regardless of market conditions. And then the other is capital markets, another platform we've been investing in, and we're seeing strong growth there. And sort of those investments and that continued growth tends to offset any headwinds we see other places. You know, we'll have some headwinds with Treasury sweep fees for off-balance sheet clients that have now moved on balance sheet.
You know, customer acquisition, kind of ebb and flow, but I think you'll continue to see us, see us have a pretty nice growth trajectory.
Got it. Any final questions? If not, please join me in thanking Harris and Shannon for their time today.
Thank you.