Zions Bancorporation NA
NASDAQ:ZION
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Good day, ladies and gentlemen, and thank you for your patience. You’ve joined Zions Bancorporation’s First Quarter 2019 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. [Operator Instructions] 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.
Good evening, and thank you, Latif. We welcome you to this conference call to discuss our 2019 first quarter earnings. For our agenda today, Harris Simmons, Chairman and Chief Executive Officer, will provide a brief overview of key strategic and financial performance; after which Paul Burdiss, our Chief Financial Officer, will provide additional detail on Zions’ financial condition, wrapping up with our financial outlook for the next four quarters. Additional executives with us in the room today include Scott McLean, President and Chief Operating Officer; Ed Schreiber, Chief Risk Officer; and Michael Morris, Chief Credit Officer.
Referencing Slide 2, 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 release – earning release as well as a supplemental slide deck are available at zionsbancorporation.com and we’ll be referring to the slides during this call.
The earnings release, the related slide presentation and this earnings call contain several references to non-GAAP measures, including the pre-provision net revenue and the efficiency ratio, both of 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.
A full reconciliation of the difference between such measures and GAAP financials is provided within the published documents, and participants are encouraged to carefully review this reconciliation. We intend to limit the length of this call to one hour. During the question-and-answer session of the call, we ask you to limit your questions to one primary and one related follow-up question to enable other participants to ask questions.
With that, I will now turn the time over to Harris Simmons.
Thank you very much, James, and we welcome all of you to our call today to discuss our first quarter results. The results for the quarter were fundamentally quite favorable compared to the year ago results. Slide 3 is a summary of several of the key highlights for the quarter, which we’ll address in detail in subsequent slides.
On Slide 4, you can see the earnings per share results for the last several quarters. In the first quarter of 2019, we reported earnings per share of $1.04. By way of comparison in the first quarter last year, we reported $1.09, although there were a couple of items worth noting.
First, we experienced a $47 million negative provision for loan losses a year ago that amounted to $0.17 per share. Additionally, in the first quarter of last year, we recovered interest income on four large loans, where the recovery per loan was more than $1 million. And those recoveries added $0.04 per share to the year ago results with no comparable large interest recoveries this year.
So excluding those two items in the year ago period, earnings per share would have increased 18%. To be fair, many of the larger banks, including Zions had a modest tailwind related to elimination of the FDIC insurance, surcharge expense this quarter. In the year ago quarter, that surcharge amounted to about $0.02 per share, whereas the surcharge didn’t occur in the first quarter of 2019.
Turning to Slide 5. On the left side, you’ll see adjusted pre-provision net revenue or PPNR, which increased approximately 8% over the same period a year ago. The chart on the right is new. As you’re aware, a new accounting standard for loan loss allowances, CECL or current expected credit losses, is expected to go into place to take effect in the first quarter of 2020.
Paul Burdiss will address that a bit more later in this call. But we are concerned as we suspect many of you are about the comparability of results arising from the new standard across banks. In this chart, we’re presenting a calculation that we’ve been using to measure the performance of our company and incentive compensation calculations for employees for quite sometime. It’s pre-provision net revenue less current period actual net charge-offs.
We’ve expressed this pre-tax number here on a per-share basis. Assisted by a strong 7% reduction in diluted shares and further improvement in net charge-offs, PPNR less net charge-offs per share increased 18% over the year ago period and 128% from the end of 2014.
Allow me to transition to a discussion of strategy for the next few moments. Just last week, we announced by way of a press release our successful implementation of what we call Release 2 of our FutureCore project. That’s a project wherein we’re replacing all of our core loan and deposit systems. This Release 2 milestone completes the conversion of our loan systems that are within the scope of the project.
This is really a tremendous accomplishment that’s required years of planning and intense work to execute it. The modern technology we’re – that we’re implementing will serve us for years to come and will allow us to more nimbly adapt digital offerings and to reliably serve our customers.
As we’ve said in the past, but it’s worth repeating, a major strategic initiative for the company is the development of technology that enables us to stay highly competitive with large national banks, small and emerging financial technology companies and community banks. We’re simultaneously working to maintain our noninterest expense growth rate in the low single digits, made possible in part by continued simplification and automation.
On Slide 6, you can see some of the key technology investments we’re making, approximately the number of customers, deposits or assets held by such customers had a rough timeframe for completing those projects. The green checkmark – the green checkmarks rather represent completed projects.
I’ll conclude my prepared remarks with Slide 7, which is a list of our key objectives for 2019 and 2020 and our commitment to shareholders. This has been updated to reflect some new initiatives that should set our course for the next several quarters.
First, over the next several quarters, we expect to continue to deliver positive operating leverage, resulting in high single-digit PPNR growth through the actions listed on page. This assumes no changes to interest rates by the Federal Open Market Committee.
Second, we have continued to take steps to dampen potential volatility in our earnings, both regard – with regard to credit as well as interest rate risk. We have talked extensively in the past about how our credit risk profile has changed. Furthermore, we are actively adjusting our interest rate risk profile to move towards a more neutral stance as Paul will discuss in more detail later.
Next, we expect further growth in earnings and improvement in our profitability. There has been some discussion by industry observers some of who – whom think the banking industry is at – is approaching peak earnings. I won’t comment on the industry, but we don’t think that Zions is at peak earnings.
We also believe we have some further room to optimize our capital ratios supported by our internal stress tests. The decision on the magnitude, timing and form of capital return is a Board-level decision and we’ll update you on any of those decisions as appropriate.
Finally, as noted in my 2018 letter to shareholders that was recently published on our website, we’re intending to invest materially in enhancing the branch experience, not with Coffee and doughnuts, but with highly trained bankers who can solve problems that small businesses experience.
This approach is supported by research, which is consistently found that small businesses continue to rank at conveniently located branch and access to an account officer as the top two features, which – for which they look when they’re considering a bank.
So with that overview, I’m going to turn the time over to Paul Burdiss to review our financial statement in more detail. Paul?
Thank you, Harris, and good evening, everyone. Thank you for joining us.
I’ll begin on Slide 8. This highlights two measures of profitability: return on assets and return on tangible common equity. As Harris noted in his comments, pertaining to our earnings per share, there were some notable items in the year ago period, namely the negative provision for credit losses and interest recoveries on loans previously charged-off. These served to elevate the profitability ratios as well.
Excluding these two items, the return on assets in the year go quarter would have been approximately 1.17% and return on tangible common equity would have been approximately 12.5%.
We are generally pleased with the recent trends in balance sheet profitability. Although the rate of improvement has slowed from the successes achieved in 2015 through 2017, we expect positive operating leverage to combine with solid credit performance and continued strong capital returns to result in further expansion of balance sheet profitability.
On Slide 9, for the first quarter of 2019, Zions net interest income increased 6% from the prior year period, up $34 million to $576 million. Excluding the interest recoveries recognized in the first quarter of 2018 that were detailed earlier in this presentation, net interest income increased about 8.5%. We did experience a moderate benefit from the higher interest rate environment, which I will discuss later in more detail, but much of the growth in net interest income is attributable to balance sheet growth.
Breaking down the net interest income by both rate and volume, on Slide 10, you can see our average loan growth of 5% relative to the year ago period. Although not listed on the slide, the period-end growth in the first quarter relative to the fourth quarter was an annualized 7.6%.
Shifting the discussion to deposits. Given the recent increases in short-term interest rates, we are pleased with the performance of our deposit portfolio. Average deposits increased 4% from the year ago period. Importantly, average noninterest bearing deposits were relatively stable, decreasing only 0.8% from the year ago period.
Relative to the prior quarter, average noninterest bearing deposits declined about 4% and period-end noninterest bearing deposits declined a more tempered 1.6%. We believe that some, but likely not all of the decline in noninterest bearing deposits is explained by seasonality.
The most valuable deposits are those which are generated through strong relationship banking and the strength of our banking relationships is demonstrated through continued growth and deposit balances, combined with a relatively modest increase in deposit costs.
Our cumulative increase in the cost of total deposits since the third quarter of 2015 that is immediately preceding the first rate hike by the Federal Reserve has been only 33 basis points or a deposit repricing beta relative to the federal funds rate of about 15%. When compared to the prior quarter, our deposit costs increased 8 basis points, or about a 36% of the change in the Fed funds rate, which is fairly similar to what we saw in the previous quarter.
Examining loan growth a bit closer, Slide 11 depicts year-over-year period-end loan growth by portfolio type, with the size of the circles representing the relative size of the portfolio. For nearly all loan categories, we are reporting solid and consistent growth. You will also find our current growth outlook for each loan portfolio type on Slide 11
Slide 12 breaks down key rate and cost components of our net interest margin. The top line is the loan yield, which increased to 4.93%, up 14 basis points from the prior quarter and 52 basis points from the year ago quarter when adjusted for the aforementioned interest recoveries. That improvement is consistent with a portfolio that has nearly 50% of loans indexed to either prime or short-term LIBOR.
Relative to the prior quarter, the yield on securities increased 11 basis points to 2.57%. The primary factor driving the increase in securities yield is new securities being added in the 3% area during the quarter and premium amortization remaining stable relative to the prior quarter, which was modestly accretive to the yield of the overall investment portfolio.
With the recent decline in yields at the five-year point of the curve, we expect security reinvestments to be slightly less accretive going forward. Cash flow from the portfolio – the investment portfolio continues to be about $200 million per month. This is important, because even as rates have moved higher, cash flow from the portfolio remains comparable to levels we experienced several quarters ago. This demonstrates some level of this – of success in our efforts to limit duration extension risk in the securities portfolio.
The cost of total funds, which includes all deposits and borrowed funds, increased 13 basis points from the prior quarter, while the cost of interest bearing funds increased by 17 basis points over the same period. When compared to the prior year, these increases are 34 basis points for total funds and 54 basis points for interest bearing funds, respectively.
This differential in the cost of total borrowed funds versus interest bearing funds demonstrates the value of noninterest bearing demand deposits in a higher interest rate environment. These elements combined to result in a net interest margin of 3.68% for the quarter, which increased 1 basis point from the prior quarter.
Year-over-year, if excluding the 7 basis points of interest recoveries from the prior period, the net interest margin expanded 19 basis points, resulting in a net interest margin beta of approximately 20% over the prior year.
As noted previously, one of the more substantial drivers of this margin expansion is the increasing value of noninterest bearing deposits in a higher-rate environment. Because of the nature of our deposits being operating accounts for businesses and households, we expect our noninterest bearing deposits to remain a competitive advantage.
I will also highlight that the spread on average interest earning assets shown on Page 15 of the earnings release, if adjusted for the previously discussed 7 basis points and interest recoveries recognized in the prior period, has decreased by 3 basis points from the prior period. The difference between the slight net interest spread compression and the net interest margin expansion is due to the contribution from noninterest bearing sources of funds.
Slide 13 typically reside in the appendix, but I wanted to highlight in my prepared remarks, because somewhat investor interest in the hedging we are doing to protect against a decline in short-term interest rates. As we announced three months ago, we’ve begun to moderate our asset sensitivity position as the recent trend of increasing short-term rates matures.
You’ll see that, we added $3 billion of interest rate floors and $700 million of interest rate swaps during the quarter. As with other balance sheet composition changes taken – undertaken over the past several years, such as capital distributions and moving cash into investment securities, we expected to change our interest rate positioning at a measured pace.
Finally, we expected our short-term interest rates to remain relatively stable, the net interest margin should be likewise relatively stable, driven by factors such as longer maturity loan repricing and securities portfolio cash flow reinvestment. The key risk to this outlook remains deposit flows and pricing.
Next, a brief review of noninterest income on Slide 14. Noninterest income and specifically customer-related fees remains a focus for us and we are – and we experienced growth in loan fees, fees earned from sales of interest rate swaps, which help our customers manage their interest rate risk, letters of credit and wealth management services.
However, that – those income – net income was offset by declines in some categories of deposit fees, including the effect of higher earnings credit rates on commercial customer deposit balances. Additionally, we experienced a modest decline in service charges on certain retail and small business products.
Before we discuss noninterest expense, which is on Slide 15, I would like to note a key change in the presentation of our financial results. This quarter and going forward, we have moved the provision for unfunded lend – lending commitments, which previously was reported as noninterest expense, up closer to net interest income to be right next to the allowance for loan losses, thus, presenting a combined allowance for credit losses and netting that against net interest income.
As a result, the provision for unfunded lending commitments is no longer in our noninterest expense line. Noting that, noninterest expenses increased to $430 million from $419 million in the year ago quarter.
As depicted on the slide, we reported an increase in compensation, much of which is due to increased profitability and very good credit quality. Also in the first quarter of 2019, we increased some key benefits to employees, which are detailed more thoroughly in Harris’s letter to shareholders and all of which are designed to appropriately reward our team for significantly improved financial performance.
Notably, it’s worth mentioning that FDIC insurance premiums are down when compared to last year, as the FDIC surcharge for large banks has been eliminated. This results in a roughly $6 million reduction for Zions, which I discussed in last quarter’s call.
Looking forward on noninterest expense, we are reiterating our expectation for slight growth, which can be interpreted as growth in the low single-digit percentage rate change – range.
Turning to Slide 16, the efficiency ratio was 60.2%, compared to the year ago period of 61.3%. The efficiency ratio calculations have some seasonality to them in that there are more days of interest income in the second-half of the year than the first and, of course, the seasonal expense increased in the first quarter of each year related to payroll taxes and stock-based compensation. We remain committed to continued improvement in our efficiency ratio in 2019.
Regarding credit quality, as seen on Slide 17, we continue to report improvement in most of our credit indicators, including a strong decline from the year ago figures in classified loans, nonperforming assets and the net charge-off picture. Even as the gross charge-off picture as seen on Page 13 of earnings release is quite strong.
Compared to the prior quarter, we reported a slight bump up in classified loans attributable to one credit, but outside of that we continue to experience improvement in oil and gas classifieds and general stability in the other categories.
Nonperforming assets plus 90 days past due improved by 7% versus the prior quarter, and net charge-offs for the quarter were zero. The allowance for loan losses ratio as a percentage of loans was largely stable with the prior quarter, with most of the provision attributable to increase in loans.
Looking ahead, we are on schedule to be compliant with the new current expected credit last accounting standard, also known as CECL, which will be effective at this time next year. Based upon our modeling, we expect more volatility in a credit loss estimate and less comparability among banks when this new standard becomes effective.
This is expected to – this expected decrease in financial performance transparency will be impacted by, among other items, varying expectations for macroeconomic trends over the near-term and loan portfolio composition differences, including expected loan lives. Zions will be in a position to disclose more in the coming quarters, including estimated financial impacts from the adoption of CECL.
Finally, on Slide 19, we depict our financial outlook for the next 12 months relative to the first quarter of 2019. We increased our outlook for loan growth to somewhat to moderately increasing, given the recent strength in net loan additions. Otherwise, there are no significant changes to our outlook from that which was and has been reported throughout the first quarter of 2019.
This concludes our prepared remarks. Latif, would you please open the line for questions? Thank you.
Yes, sir. [Operator Instructions] Our first question comes from the line of Ken Zerbe of Morgan Stanley. Your line is open.
Great, thanks. Good evening, guys.
Hi, Ken.
I was just hoping to actually stay on the loan growth topic. Paul, I know you just hit the very end of your prepared remarks mentioned, it sounds like the improved outlook was due to sort of what you’ve already seen. But I was hoping you could actually talk about what you’re seeing in 2Q in terms of loan growth?
And I also want to make sure I just understand. Your outlook is moderately increasing, which is better than what it was before and that applies for the next 12 months. It seems that your loan growth outlook should be kind of better than on an already higher first quarter balance. Is that the right way of thinking about it?
Well, I’ll start and I’ll ask Scott and maybe Harris to chime in. First of all, with respect to the second quarter, it’s so early in the quarter, it’s really hard for us to make any meaningful commentary on that topic. But as you point out, we have through the language we’re using, we’ve tried to telegraph a, I would say, kind of a slight increase or improvement in our loan growth outlook relative to what we saw in the prior quarter. And as I said in my prepared remarks, that’s largely because of the kind of the engagement and the strength that we’re seeing in net loan portfolio additions.
Scott, would you like to add anything?
Yes. Ken, I would – I just add that if you look at Slide 22, and basically, our year-over-year growth rates running kind of mid-5s. The first quarter annualized is a bit faster. We’ve been guiding towards mid single-digit loan growth for three, four years now and sometimes it’s going to kind of 3.5 years to four, and sometimes it may get up to six to seven.
But I think it’s still very much in the band that we’ve talked about. And the growth that we’re seeing really is very consistent with the last – the previous two quarters and the last three or four years, basically 40%, 50% of it’s coming from C&I. We’re seeing some CRE growth, but the CRE portfolio is still really hasn’t grown much if you go back 15 to 18 months, and then really solid growth from one to four family that generally makes up about 20% – 25% of our growth rate.
We’re also seeing really nice growth across all our affiliates depending on the quarter. But I would say, more consistent growth coming from our four smaller affiliates than we’ve seen historically. So just good balance growth.
All right. [Multiple Speakers]
I would – as you can see here that, I guess, two other sub-portfolios, municipal has been growing nicely over the last two years as a result of the strategic initiatives we’ve had there and should continue to grow. Again, it’s really a nice yielding loan type and really high credit quality, where ancillary business is starting to flow from it. And our energy portfolio recall that it went from about $3 billion in outstandings down to about $2 billion – a little less than $2 billion.
We’re now back up about $300 million and we’re very happy with that loan growth. The energy portfolio is about $2.3 billion, and the mix has shifted significantly. Oilfield services was about 45% at the peak, it’s now about 22%. And our energy services term loans, which is where we had the greatest loss rate, they’re now less than $400 million. So it’s a really good mix shift there and most of our new findings are going into reserve base and midstream.
Okay. And just my related follow-up. Can you just talk a little bit about your outlook for deposit price increases now that the Fed as far as we’ve done raising rates?
Yes. Ken,. I’ll start with that and allow again Scott or Harris to jump in. We’re really excited about the performance of our portfolio over the course of this rate cycle. That being said, we have seen a modest acceleration in the deposit repricing over the last couple of quarters.
My expectation is, with the flatness of the curve and with the Fed appearing to be sort of on pause maybe indefinitely here as it relates to rate increases, the further we get away from the event of Fed tightening. My expectation is that the pressure that we’ve been seeing on deposit pricing will begin to abate over the next couple of quarters.
Gotcha. Okay, perfect. Thank you very much.
Okay.
Thank you. Our next question comes from the line of Dave Rochester of Deutsche Bank. Your line is open.
Hey, good afternoon, guys.
Hi, Dave.
Just on the outlook slide, you guys have mentioned here your efforts to reduce payoff activity. I was just wondering what steps you guys are taking on that fund, if that was what helped the growth this quarter versus maybe a pickup an origination activity?
Yes. Dave, this is Scott McLean. We did see a higher success rate in retaining CRE term loans and as opposed to them being refinanced into the secondary market. And so – and then, it – Michael, you may recall the number, but I think it was a $300 million to $400 million sort of benefit during the quarter. And so nice progress, and we really haven’t seen that kind of progress on that front, but we got a little more aggressive in marketing to those more earlier in the renewal process.
Okay, great. That’s a good color. And then I know you said, it’s early in 2Q. But are you continuing to see momentum in the loan pipeline heading into 2Q at this point just given what you’re seeing so far that’s sort of locked in to close?
Again, it’s too early to comment. But we’ve really – since the third quarter of last year, late second quarter of last year all the way through the end of the year and through the first quarter, we’re just seeing good balance growth and we anticipate that to continue.
Okay, great. Thanks, guys.
Thank you.
Thank you. Our next question comes from the line of Ken Usdin of Jefferies. Your line is open.
Thanks. Good afternoon, guys.
Hi, Ken.
Well, wondering if you can talk a little bit more about the hedging strategies that you discussed in the deck and earlier. So how much way through your planned hedging program are you? And can you talk a little bit about whether you’re either benefiting from putting on those hedges now, or have to amortize a little bit of cost and is that baked into your outlook? Thanks.
Yes. Ken, I’ll start with the second part. With the flatness of the curve, there’s clearly no benefit to putting hedges on today. In fact, it’s a modest – very modest immaterial, which is why I didn’t say it, kind of a modest reduction in net interest income.
But with respect to the program itself, we do not have a – the ALCO, that is the Asset Liability Management Committee, doesn’t have a specific target in mind other than the expectation is, we will in the near-term, at least, continue to work down that interest sensitivity.
And specifically, as I said on the call, we are particularly concerned with falling interest rates. And when you consider the behavior of our deposit pricing over the course of the last couple of years, you can see where in a decline in rates, the deposits could floor out pretty quickly. Our concern, of course, is that we’ve become very asset sensitive in a falling rate environment, which is why you saw in addition to the swaps, why you saw us put $3 billion of rate floors on, because affectively that would be offsetting the impact of the deposit pricing in a falling rate environment.
So I would say…
Okay.
…we’re kind of trying to be a little more specific. And to your question, I’d say, we’re still pretty early on in the hedging process with a lot more to come.
Okay. And a follow-up on the mix of the balance sheet. You mentioned the outlook slightly declining securities portfolio balances. Up till now, you’ve been funding using the deposit growth to fund both loans and securities. Are you now with a point, where you’ll remix a little bit more on the asset side, just funding loan growth more incrementally with securities rather than necessarily paying up for more deposit growth? Just want to understand what you’re thinking about that? Thanks.
Sure. Our securities portfolio exists, as I’ve discussed previously; first, demand liquidity and second, demand interest rate risk. And so, our priority is ensuring that we have an investment securities portfolio that is adequate to maintain liquidity on the balance sheet.
But all that being said, obviously, there is a cost to liquidity. And so we’re measuring or monitoring that very closely. As loan growth has really begun to exceed deposit growth, where going back and looking our investment portfolio and really ensuring that it is of the appropriate size. And so, my expectation certainly is that the portfolio will not grow from here and, in fact, will likely on either an absolute or relative basis will decline a little bit.
Okay. Thanks a lot.
Yes. Thank you.
Thank you. Our next question comes from John Pancari of Evercore. Your question please.
Good afternoon.
Hey, John.
On the margin side, I know that you had indicated for – your expectation for net interest income to be moderately increasing. Given that outlook, I mean, can you talk about how that plays out in terms of the margin trajectory from here? I believe you have previously expected some stability here on out, but clearly, you’ve got the swap impact and the impact of the curve. So want to get an idea how you’re thinking about the trajectory of the margin from here?
Sure. On the interest rate hedging, as I said, we’re really not seeing benefit – certainly not seeing a benefit, but we’re really not seeing a good traction from the margin either, at least, in the current environment. Now all that being said, in my prepared remarks, I mentioned net interest margin stability as we see some kind of repricing in the loan portfolio and especially in the securities portfolio. But the key to that outlook is deposit pricing and deposit flows.
And so as long as we can continue to maintain appropriate share of noninterest bearing demand deposits and so long as the interest bearing portion of the deposits, remains consistent – priced consistently with our expectations. And importantly, as long as we don’t get seriously out of whack in the balance of loan growth and deposit growth, kind of all of those are implied assumptions in that margin stability, and there’s probably more risk to the downside than the upside in the current environment.
Got it. Okay. [Multiple Speakers]
But all that being said, if I – sorry, John, if I could. All that being said, I – we are really focused on growth in net interest income and growth in revenue. And so, we don’t specifically manage to the margin, as you know. We’re far more concerned with revenue growth than the margin, which is a kind of an indication of relative profitability.
Got it. Okay. And then separately on the expense side, the efficiency ratio, I know you indicated you expect the continued improvement in positive operating leverage as well. Can you talk about how you think about it for full-year 2019? Could it still come in below the – we’re still expecting below 60% range. And then long-term, I know you’ve indicated mid-50s. Is that still a fair assumption? And what do you think about the timing until when you can get into that mid-50 range? Thanks.
Sure. Well, in 2018, as you know, we did report efficiency ratio that was below 60%. And in my prepared remarks, I mentioned that we’re expecting continued improvement. So you glue those pieces together and you can see that our expectation is for an efficiency ratio that’s below 60% in 2018. I absolutely think that, it’s achievable to get into the mid-50s.
I don’t – we don’t have nor we put out a kind of a timeframe associated with that. But we’re really focused on as we think about our plans and our forecast. We’re really focused on positive operating leverage and the degree to which we can increase that leverage absolutely affects the timeline that will – we will be able to achieve that efficiency ratio outcome.
Okay. Thanks, Paul.
Yes. Thank you.
Thank you. Our next question comes from Brad Milsaps with Sandler O’Neill. Your line is open.
Hey, good afternoon.
Hi, Brad.
Scott, I was curious if you could maybe offer a little more color on the loan growth specifically in Texas? It looks like that was your really big driver this quarter. I know you talked a little bit about the CRE. But just any additional color for Texas specifically? And what are the chances that you can kind of keep that type of growth rolling in that market?
Absolutely, Brad. So keeping that kind of loan growth at that pace would be unrealistic and uncharacteristic with the – with how Amegy has grown historically. So I would just hit that really quickly. And it’s about less than $600 million of growth during the quarter. And basically, if you look back at Amegy for the last 12 months, there was very – last 12 to 15 months, there was very little growth in Texas.
Texas was still coming out of the energy downturn in kind of the malaise, the post-Harvey malaise, which was the fall of 2017. All of that has – all of those clouds have cleared off. And so Houston, which is where about 70% of the loan growth in Texas comes from is – really is performing quite well, and Amegy is benefiting too from its many years of investment in Dallas-Fort Worth and San Antonio and Austin. 30% of growth is coming from those markets now and those economies are doing well.
So if you just kind of step back, C&I growth during the quarter was about $300 million, about a third of it was energy, a third of it was municipal. And then they had a couple of larger transactions really four to be precise, that could have quite frankly closed in the fourth quarter and for a collection of unrelated reasons ended up closing in the first quarter. So there’s a little bit of a timing thing there.
And the CRE growth that you see in Texas, you can see all of this on Slide 22, about $170 million of growth, it’s mainly coming through construction loans that were originated about a year ago. And from a historical context standpoint, the CRE portfolio in Texas is still about what it was in December of 16, almost three years ago. So, there – it looks like a lot of growth in one period, but over an extended period of time is equivalent to where that portfolio has been.
Great, that’s helpful. And just as my follow-up. Paul, the decline in DDA was pretty consistent with what you guys typically see in the first quarter. Anything in your mind that those dollars wouldn’t come back in the fold as you kind of progress through 2019, given where rates are now? Just kind of curious any thoughts on the DDA as you kind of move back to the seasonally stronger quarters for you guys?
Yes, sure. The – I would say that the DDA decline was probably a little bit more than what would be expected from just seasonality. So, our ALM models would indicate that over time, we would expect to see a little less DDA and a little more interest bearing deposits.
So it’s really hard for me based on this one quarter to discern a trend. I would only say that, look, versus last year and certainly over the last several years, our DDA has continued to be strong and well over 40% of our total deposits. And so, based on that experience, I’m expecting continued strength there.
Thank you.
Thank you.
Thank you. Our next question comes from the line of Erika Najarian of Bank of America. Your line is open.
Hi, good afternoon. I just want to…
Hi, Erika.
…hi. I just wanted to go back to the statement during prepared remarks about Zions’ earnings haven’t peaked. And I just wanted to unpack that a little bit and sort of expand that beyond the 12 month’s look. When you gave us guide for revenues and expenses, I think that clearly the curve outlook keeps changing. And I’m wondering if your statement is supported by business growth that you’re seeing or your ability to change your expense base relative to the revenue outlook?
Well, I’ll start with that and invite Harris and Scott to join in. I – as I said, we are – this is Paul. We are really focused on positive operating leverage. So to the extent, our revenues exceed expenses in terms of growth, we will absolutely continue to see improved profitability.
And so your question was, do we have the ability to sort of change our expenses relative to revenues? I think we’ve demonstrated that over the last three or four years. We have absolutely, while making a massive investment in the business, have been continuing to report controlled expenses and expense growth that is lower than revenue growth. And so, our expectation that, that has been a tightly managed process here. And my expectation is, we’ll be able – continue to be able to achieve that.
Yes. I’d just add that. I think if we look at the economy in the markets we operate in, we’re just not seeing any real signs of the slowdown. I mean, the one maybe – the exception to that would be just construction trade is really tight, that’s Denver the other day and they – there’s a fair amount of discussion about the impact that’s having just kind of slowing things down.
I’m not sure that that’s maybe kind of a high-class problem, because I think it’s probably acting as a governor on the kind of growth that can get you the trouble, too. But it’s – fundamentally, the economy is – across the Western United States is pretty strong. I also think that we have the benefit of not having probably quite as much pressure on funding loan growth that some others do.
We have a pretty good liquidity situation, and I think that gives us a little more room probably to see some loan growth without having it create too much pressure on the deposit side. So I’d just add those to the mix and we’re going to keep very focused on the expense side.
I do think that, I mean, the fee income piece of the puzzle looking across the industry, that’s clearly proving to be a challenge across the whole regional sector. And we’re no exception, but I think we nevertheless have – we probably have a little less drag that’s going to come from consumer fee income, deposit fee income on the consumer side, because it’s just not as big a piece of our picture. And I think that’s, in my mind, one of the great challenges the industry generally has.
And so we probably – I’m a little more optimistic in terms of what we can do on the fee income side than it might otherwise be. So, we add it all up and we think – and we also think that credit quality is just really good. And it’s hard to – you can’t stay at zero in terms of getting net charge-off for forever. But we’ve been there now for about for a year and we just don’t see a lot of change in that picture. So I think the provision drag is going to be pretty modest here for the next two or three quarters.
Got it. I mean, my follow-up question is on the concept of not much pressure on funding loan growth. On the other side of that, as you think about the securities reinvestment, Paul, could you give us a sense on the reinvestment strategy and also the yield that you’re looking at right now in terms of reinvestment?
Yes. Well, we have been really disciplined. As we’ve talked about a lot over the last couple of years and quarters, I think, we’ve been really disciplined in where we are investing along the curve. We have an investment portfolio that is relatively short.
We don’t have any 30-year paper in there. It’s a maximum of 15-year final maturity with respect to the MBS that we hold and that’s continuing. And so, the going-on yields of the portfolio in the first quarter were kind of in the 3% range. It’s probably a little south of that now given sort of what’s happened with respect to the curve.
But as I mentioned on the call, the fact that the cash flow within the portfolio has been really consistent here for the last several or many quarters is indicative of the, I would say, the way we’re managing the duration extension risk and because the duration is relatively short and because the cash flows have been proven to be predictable, we will continue to reinvest it at the prevailing rate, which we think is an important as we’re thinking about tightly managing that portfolio and being able to extract liquidity out of it, if need be, but also kind of reinvesting at the prevailing rate.
Great. Thank you.
Thank you.
Thank you. Our next question comes from Peter Winter of Wedbush Securities. Your line is open.
Thanks very much. Could I ask just given your prior comments about the economy and credit, you have increased the share buyback last couple of quarters. And I’m just wondering given a positive outlook, would you continue to look to accelerate the buybacks?
Well, obviously, as you said, we have a little stronger loan growth that, that could actually change your thinking somewhat. But it’s – as we said in our remarks, it’s really a Board decision and it’s one that we are going to always be very careful about getting out over our skis until we have that conversation with the Board.
So, I mean, I think we have – we said that we think that we still have some room to optimize our capital ratios. But kind of the timing and that is something we just look at every quarter. So I’m not going to speculate further.
Okay. And then Paul, just my question to you. You’re certainly a little bit more positive on the outlook on deposit costs, just given the flattening yield curve and the Fed on hold. I’m just wondering if you could be a little bit more specific what you’re looking for in terms of deposit increase on the interest bearing deposits, both in the second quarter and kind of second-half of the year, I would think it would slow even more?
Yes, I appreciate your question. However, it’s really hard for me to be a lot more specific than I have been. I – as I’ve noted in the past, we – we’ve had some modest increases in what else, I’ll sort of the Board rates. But really where we are managing tightly, the deposit pricing is largely through exception pricing.
And so it’s really – as we’ve seen over the last kind of a year, six months to a year, where we’ve really seen a lot of pressure is in the larger average balances sort of deposits. That’s where we’ve seen a lot more deposit beta, if you will, most of our deposits, particularly DDA, our operating accounts, very, very granular, very, very small sort of deposit – average deposit size.
And so it’s hard to put a specific basis point expectation on it, which I think is what you’re asking for. What I can really say qualitatively is that, where we’ve seen pressure is in these very large deposit or balances. And fortunately, on a relative basis, we just don’t have a lot of those. The vast majority of our deposit composition is from relationship-based operating accounts.
I would just add to that. Peter, this is Scott, that we do have a moderately sized bucket of customer deposits that are off-balance sheet that are being swept into overnight money market funds. And we may see some growth in our own interest bearing liabilities that just comes from moving instead of paying that FHLB or broker deposits, you may see those balances come down and what we think of is wholesale deposits coming up, because to the extent we can move those client balances back on balance sheet at rates that are less than and we can less than what we’re paying broker deposits or the FHLB, you’ll see us do that.
Got it. Thanks for taking my questions.
Thank you.
Thank you. Our next question comes from the line of Kevin Barker of Piper Jaffray. Your line is open.
Hi. Just a follow-up for Ken on deposits. I mean where do you feel you could – do you feel comfortable with loan deposit ratio getting into the mid to high-90s if that were to occur? And what type of environment do you expect that to occur if it did?
I’ll start with that and ask Scott and Harris to join us if they feel like. I would absolutely be comfortable of a loan to deposit ratio in that high-90s. I think, loan to deposit ratio is an indication of two things, I think, liquidity and profitability. We can absolutely manage the loan to deposit ratio lower by going out and buying money.
But that’s – so loan to deposit ratio, I think, again, historically has been viewed as a measure of profitability, but I think it’s a little flawed, because it doesn’t necessarily consider the sort of the nature of the deposit you’re bringing in. And likewise as a measure of liquidity, it’s also, I would argue not particularly useful, because we can manage liquidity through term funding that is not deposit-based.
So, looking at just the ratio, could I get comfortable with a loan to deposit ratio in the 90s – mid-90s. Yes, I absolutely could. The most important thing for us is managing and maintaining profitability and liquidity and we have been doing that and will continue to do that.
Okay. And then just follow-up on expenses, core expenses were up just under 5% on a year-over-year basis. You expect that – the growth to – it seems like it’s going to slow, given your guidance. Can you just give us an idea of the cadence of the year-over-year growth as we move through 2019?
Well, as you look at seasonality of expenses, you always see an uptick in the first quarter or historically you have, because you’ve got payroll taxes and you’ve got stock-based compensation for retirement eligible employees and there are things like that that happen in the first quarter they don’t repeat.
And so you really need to take that sort of increase in the first quarter and spread it out over the course of the year. That being said, we have a detailed budget and forecast that we believe would support the outlook, which is noninterest expense in that low single-digit range.
Okay. Thank you.
Yes. Thank you.
Thank you. Our next question comes from Lana Chan of BMO Capital Markets. Your line is open.
Hi, good afternoon.
Hi, Lana.
Paul, can you just give us any color in terms of just with the last answer in the personnel-related seasonal expenses this quarter, how much it added? How much we should come out in the second quarter?
Well, I would encourage you to kind of look at, if you could just look at the – I think we have enough disclosure in the financials to sort of look at the trend in compensation expense and where you would – you can see that sort of bump up. I mean, it’s in the range of – it’s kind of between $5 million and $10 million. But I think you can probably call that out if you look at the trend in that incentive compensation – or in that compensation expense line.
Okay. And then on customer-related fees, I think, you guys talked about some softness on retail and small business service charges. Is that seasonal or is that more of an ongoing factor for fees going forward? I just wanted to – $120 million of customer-related fees, I want to see if we expect any recovery in that going into the second quarter?
Yes, Lana, this is Scott. That particular item retail and small business service charges has been weak for five years. It is for the industry, it has been for us. We have one year where it increased, and I think it was 2017. And then in 2018, latter half of 2018 and into 2019, we’re seeing some continued softness there. So it – I wouldn’t think of it as seasonal and I wouldn’t think of it as an unusual trend. It’s actually a trend we’ve been watching for and trying to counter for sometime.
Yes. I think one of the things – this is James. One of the things that’s consistently down is the non-sufficient funds fees. And I think as we – as the credit quality of our customers gets better and better and technology allows customers to see their balances in a real-time fashion and provides customers tools to be able to manage that type of thing. That’s one of the natural fallouts of that is that we see a little less of that fee for example.
Okay, thank you. It’s helpful.
Thank you, Lana.
Thank you. Our next question comes from Steve Moss with B. Riley. Your line is open.
Good afternoon. I was wondering if we could get a little further into the leads on the hedging transactions. In particular, wondering what the average term of both the rates of the swaps and the floors are and what is the rate on the floors?
Yes. These are, by and large, three-year sort of arrangements. The rate floor is about 100 basis points out of money, so they’re kind of around 1.5.
Okay. And then my second question, just wondering here what was the driver of the uptick in 30-day, 90-day delinquencies quarter-over-quarter?
Sorry, we’ll have to – I don’t think it was big obviously. And so I think that was probably noise in there.
It was just a noise or timing. There wasn’t anything material.
But if there’s something material or specific in there, we can certainly get back with that.
Okay, thanks.
Thank you. Our next question comes from Steven Alexopoulos of JP Morgan. Your line is open.
Hi, everybody.
Hi, Steven.
I’d like to follow-up on the offsets to potentially higher deposit costs, which are underlying the stable NIM assumption. The security yields, the new ones are definitely a lever. But how much above the current loan portfolio yield are new loans coming into the book?
Well, it gets to the loan mix, which is – we’ve been talking about this sometime and that’s important. So it’s not just a matter of new loans coming on in the rate of new loans, but the composition of the loan portfolio we’ve seen better growth, for example, in commercial real estate and some construction. Those generally have better yields than, for example, residential mortgage. So it’s a combination of those things in addition to the shape of the curve, which I think is kind of what you’re describing.
And I would just add, Steven. There – our loan officers do report there’s continued pricing pressure. So come from quarter-to-quarter, year-over-year a few basis points on, at least, the major food groups, if you will. So it’s – although the yield on new production is higher than the overall portfolio yield, some of the new loans that are coming on are being refinanced or refinancings of existing because of the improvement in credit quality and other factors, we are seeing some price competition. So there is a little bit of yield compression, if you will, every quarter from that factor.
Okay, that’s helpful. And then I had a follow-up for Harris. You said in your opening comments that you’re investing in the branch experience. I think you said more than just coffee and doughnuts. What are you planning and will we see this impact earning – expense growth? Thanks.
I don’t think you’ll see that materially impact expense growth. But we are being very – we’re very focused on trying to take the people we have in our particular branches and give them opportunities to develop additional skills and with that little bit of additional authority and we hope to over time to increase the tenure of people we have there.
It’s tough to say your relationship bank work to do the kinds of things that actually create relationships, which include just having the same people there for a long period of time and having them trained and qualified to deal with particular – with smaller – kind of the small to small, mid-sized kinds of businesses that frequent branches a lot and particularly in our franchise.
And so that’s kind of what we’re determined to do, and I don’t think it’s not going to be something that happens overnight. But I absolutely believe that it’s going to be an investment that will yield returns greater than any cost we put into it both in terms of morale and in terms of just creating the kind of sticky relationships that we hope we would have out in our branches. And I’d also say, it’s something that we don’t think many of the larger banks are very focused on. I mean, branches have become sort of this necessary inconvenience for a lot of folks and we think about it a little differently, I think.
Okay, great. Thanks for all the color.
Thank you, Steve.
Thank you. Our next question comes from Christopher Spahr of Wells Fargo. Your line is open.
All right. Thanks there. I’d like to ask a question. Just a question on the capital authorization. When should we expect there to be a Board meeting, or is it reasonable to expect the Board meeting a week-and-a-half from today or towards the end of next week?
That’s reasonable.
And then the pace of buybacks, it has picked up the last couple of quarters. Would it be reasonable to think of the pace of buyback, could it actually increase again further, or are you kind of content with the pace that you’ve set for the first quarter?
We’ll just – we’ll be announcing something I expect by the end of next week, and I’ll let it wait until then.
Great. Thank you.
Great. Thanks.
Thanks, Chris.
Thank you. Our next question comes from Brock Vandervliet of UBS. Your line is open.
Thanks for taking the question Just sneak in on the line here.
Yes.
So just within the commercial real estate portfolio, I know you mentioned the construction and development, and I was showing some growth from draws that have been in place for a while. But the term category seem to be up pretty consistently the last four quarters. Is that indicative of your greater comfort and confidence in that segment, or better pricing or a bit of both?
This is Michael Morris, I’ll respond to that. The C&D growth really is for our premier clients, so most of the C&D growth that you see would not be new to bank clients. And the CRE term growth would just be a factor of either renewing or as had been mentioned earlier, moving from construction to term loans that are already on the books. And some acquisition of new loans, some new term CRE facilities here and there, but not indicative of a major trend or marketing strategy. It’s business as usual and everything is well within our risk management framework in terms of concentration limits and underwriting.
Got it. Okay. And separately on the provision line, I see the guidance of modest provisioning and that’s been consistently lower than I would have expected, given the recoveries and things. Any further color you would give in terms of the provision, the remainder of the year or the cadence of it that we should be kind of be thinking about?
Yes, I’m going to start – this is Paul. Obviously, there are a lot of accounting rules, kind of most importantly that we need to think about. This is the largest estimate in our balance sheet. And so we need to build it sort of loan by loan up every quarter, which is what we do.
And so our comments are really around expectations of kind of underlying credit trends. And we have not seen – we have seen continued improvement in credit trends over the course of the last several years, maybe the pace of improvement has slowed a little. But that sort of underlying trend of continuing improvement feels like it will continue for the foreseeable future. So, the expectation is that, we’ll continue to provide for a loan growth and that’s really what’s reflected in the outlook.
Got it. Okay, thank you very much.
Yes. Thank you.
Thank you. Our next question comes from Brian Foran of Autonomous. Your line is open.
Hi, good evening.
Hi, Brian.
Paul, I just want to clarify. I think earlier, you were talking about deposits as a key swing factor to NIM and you mentioned there was more downward pressures than upward – or downward risk than upward right now. Was that downward risk you’re seeing for the NIM, there’s more downward risk or just for the deposit commentary?
Yes. That commentary was really – that sort of come out over the Q&A of the call I think that the opportunity for upside on interest rates loan securities is probably a little more limited, given sort of the shape of the curve and what we’re experiencing there. So the upside is a little more limited, whereas the downside on the deposit side that is the risk of an increase in deposit rates exceeds the risk of increases in the loan yields. And that’s sort of that balance is all I was trying to capture with that commentary.
Got it. And then, Harris, I guess that you had made a comment that credit costs don’t stay at a year forever, but they could for the next couple of quarters or near zero anyway. As someone who has seen a few cycles, I mean, what are the kind of key things you’re watching right now to try to gauge – what are you looking for to kind of see the turn coming, if and when it eventually does?
It’s just – it’s watching nonperforming assets trends, non-accrual, the criticized classified trends, and we had a little bit of a bump up from one deal that’s going to resolve itself this past quarter. But I think fundamentally, we’re just not seeing any sort of emerging storm clouds in terms of something that would cause us to think that these gross charge-offs can change very materially.
I mean, the recoveries will get – it will – I mean that obviously kind plays itself out, and you have less to pick through as you get further away from the energy event of three years ago on, et cetera. But the fundamentally, if you look at gross charge-offs, they’ve been in very good shape, and I don’t really see that changing at least as far out as we can really reasonably see, which is probably the next couple of quarters like that.
Thank you very much.
Yes. Thank you.
Thank you. At this time, I’d like to turn the call back over to James Abbott for any closing remarks. Sir?
Thank you, everyone, for joining on the first quarter 2019 earnings call. We appreciate your time. I will be around this evening for further follow-up questions, if you have them and throughout the rest of the week, of course. And again, we appreciate your attendance today and thank you. We’ll see you at the next earnings call or the conference. Thank you so much.
Thank you. Ladies and gentlemen, this concludes today’s conference. Thank you for your participation, and have a wonderful day. You may disconnect your lines at this time.