Zions Bancorporation NA

NASDAQ:ZION

Earnings Call Transcript 2019-Q4

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the Zions Bancorporation's Fourth Quarter 2019 Earnings Results Webcast. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator instructions]

I would now like to hand the conference over to Director of Investor Relations, James Abbott.

[James Abbott, Director of Investor Relations]

Thank you and good evening. We welcome you to this conference call to discuss our 2019 fourth quarter and full year earnings. For our agenda today, Harris Simmons, Chairman and Chief Executive Officer, will provide a brief overview of key strategic and financial performance figures; after which, Paul Burdiss, our Chief Financial Officer, will provide additional detail on Zions' financial condition, wrapping up with our financial outlook. Additional executives with us in the room today include Scott McLean, President and Chief Operating 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 in this call. A copy of the full earnings release as well as a supplemental slide deck, are available at zionsbancorporation.com. We will be referring to the slides during this call.

The earnings release, the related slide presentation in this earnings call contain several references to non-GAAP measures, including pre-provision net revenue and the efficiency ratio, which are common industry terms used by investors and financial services analysts. The use of such non-GAAP measures are believed by management to be of substantial interest to the consumers of these financial disclosures and are used prominently throughout the disclosures. A full reconciliation of the difference between these 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.

I'll now turn the time over to Harris.

[Harris Simmons, Chairman and Chief Executive Officer]

Thanks very much, James. And we welcome all of you to our call today to discuss our 2019 fourth quarter and full year results. Slide 3 is a summary of several key highlights, which I'll cover in the next few slides. So I'm going to move right to Slide 4.

Slide 4 shows a time series of the bottom line earnings per share results. We reported earnings per share of $0.97. As noted on the slide in the fourth quarter of 2019, there were three items that adversely affected the earnings per share figure by a net $0.17. Also shown is the adjusted pre-provision net revenue, which is noted already excludes the impact of $37 million of non-interest expense related to severance and restructuring charges. However, the PPNR number also includes the positive impact of the derivative valuation gain on client-related interest rate swaps, and the $10 million adverse impacts associated with the resolution of the self-identified operational issue.

Moving to Slide 5, the efficiency ratio is of course a function of both revenue and expense, with a relatively quick change in the trajectory of interest rates in mid 2019 and the expectation is such a change would create a revenue headwind. We took action to adapt quickly on the expense front in order to actively manage our profitability. We announced three months ago in conjunction with our third quarter earnings release a plan to cut about 5% of our staff positions and a number of other positions that were not yet filled.

We also said that the resulting reduction in salaries and benefits would be roughly proportional to the number of positions eliminated and that these reductions should be reflected in our financial results beginning in the first quarter of 2020. We'll continue to work to reduce the variety of costs and execute on plans we've announced to realign certain branches during 2020. In short, we've tried hard to respond to a rapidly changing business environment, really an interest rate environment. And I believe these efforts should help to offset some of the interest rate related revenue challenges we expect in 2020.

Turning to Slide 6. One of Zion's strengths is its sizable portfolio of non-interest bearing deposits, which account for more than 40% of total deposits. During the fourth quarter, average non-interest bearing deposits increased an annualized 7.5%. Average total deposits increased an annualized 10.5%. The cost of deposits declined 6 basis points, which equals to 12% linked quarter improvement relative to our third quarter total cost of deposits.

Going now to Slide 7. Credit costs remain low. Consistent with my comments last quarter, credit losses have been somewhat episodic within our loan portfolio attributable to problems specific to a small handful of borrower's unique circumstances. Net charge offs for the full year were a modest 8 basis points, generally consistent with our expectations for the year.

Non-accrual loans and loans and 90 days past due continue to show improvement. Our non-performing assets plus loans 90 days past due, expressed as a percentage of loans and other real estate owned at 51 basis points, was 4 basis points lower than the year ago period. Our improved risk management and credit performance have been key factors in improvement in our debt ratings in the recent months.

Due largely to the strong credit quality of the loan portfolio, resulting in part from a shift in recent years in the portfolio's composition to what we believe is a less risky credit profile and due to a reduced risk profile generally, we have been able to reduce our capital ratio as to level closer to that of our peers. We're pleased to have repurchased more than 3% of our outstanding shares in the fourth quarter and more than 12% of our shares during 2019. In addition to a substantial buyback program during the past few quarters, we've also been delivering an annualized common dividend yield of nearly 3%. Our common equity Tier 1 capital ratio remained strong at 10.2%.

Next let me step back from the financial data and update you on just one of the variety of strategic initiatives we have underway, and that's the digital delivery. Shown on Slide 8. We're enhancing digital experiences for our customers with a goal of being quite competitive with best providers financial services products, banks and non-banks alike. While remain focused on continuous improvement in streamlining our processes, thereby, keeping non-interest expense under control. We continue to make solid progress, notably in small business and consumer digital account opening in small business and mortgage digital loan application processes.

Additionally, we're on track to significantly enhance our online consumer and small business mobile platforms later this year. Our core replacements initiative remains on track. And I've noticed that at least a couple of other of our peers have recently announced that they would be embarking on some form of core systems replacement projects. We'll spend a significant amount of time on our core systems' replacement and our other technology initiatives at our Investor Day in just two weeks.

With that overview, I'm going to turn the time over to Paul Burdiss to review our financials in additional detail. Paul?

[Paul Burdiss, Chief Financial Officer]

Thank you, Harris, and good evening everyone. Thanks for joining us. I'll begin on Slide 9, which highlights two measures of balance sheet profitability, return on average assets and return on average tangible common equity. As noted, the fourth quarter results were adversely impacted by the severance and restructuring charges and the resolution of our operational issue, and positively impacted by a derivative valuation gain on customer related interest rate swaps. Combined, these factors adversely impacted return on average assets by about 20 basis points and return on average tangible common equity by about 200 basis points. We remain focused on continuing to improve balance sheet profitability.

On Slide 10 looking at the chart on the left. Zions' net interest income declined slightly compared to the prior year period. While average earning assets increased by 3% during that timeframe, the yield on earning assets decreased by 17 basis points and the cost of interest bearing liabilities increased by 2 basis points, leading to a decline in the rate spread of 19 basis points and a decline in the net interest margin of 21 basis points. Net interest income was down 3% over this period as the decline in net interest margin was somewhat offset by balance sheet growth.

Turning to a linked quarter view. The net interest margin compressed 2 basis points relative to the third quarter, as the lower interest rate environment continued to impact loan and securities yields and also led to lower borrowing costs. The waterfall chart on the right depicts the elements that resulted in the linked quarter change in net interest margin. Within the loan yields bar, about half was portfolio churn, sometimes referred to as the front book and back book, while the other half was due to the change in benchmark interest rates.

On the funding side, the net interest margin impact of the cost of funds decline was evenly mixed between the cost of deposits and the cost of wholesale funds. As Harris noted, highlights in the quarter included the growth of deposits and the decline in the cost of average deposits. While our cost of funds increased 3 basis points over the year ago period, it decreased a solid 14 basis points from the third quarter of 2019 to 57 basis points from 71 basis points, or about a 20% improvement in cost. This was primarily due to lower rates paid on all interest bearing liabilities in addition to a favorable mix shift, as solid deposit growth made it possible to reduce wholesale borrowings. We expect that the net interest margin will compress further during the next couple of quarters, reflecting the forward curve and our best estimates of loan yields, deposit costs, balance sheet churn and other factors.

Slide 11 highlights a key component of net interest income, loan and deposit growth and breaks them down by both rate and volume. Average loans grew 5% over the year ago period. Average loans in the fourth quarter were essentially flat to the prior quarter. As we have noted previously, it is not unusual to observe a quarterly ebb and flow to balance sheet growth due to several factors, including customer demand, the balance of loan growth and payoffs and seasonality.

Over the prior year period, the yield on loans decreased 23 basis points and relative to the prior quarter, the yield on loans decreased 19 basis points. As I noted in the discussion of the previous slide, about half of the linked quarter compression in loan yields was due to movement in benchmark interest rates and the other half can be attributed to the churn of the portfolio, where new yields are 15 to 20 basis points less than maturing loan yields.

Shifting to funding. Average total deposits increased 5 percentage points over the prior year period and a solid 10 percentage points annualized growth rate when compared to prior quarter. As I noted the last quarter, maintaining this rate of growth in deposits will be difficult, especially with seasonal factors typically seen in the first few months of the year. Nevertheless, we expect moderate deposit growth to accompany our loan growth for 2020.

Slide 12 is a new slide and shows the changes in our investment portfolio size and yield, and changes in our borrowed funds position size and yields. As I have mentioned on previous calls, we reevaluated the on balance sheet liquidity a few quarters ago and in conjunction with that analysis, selected to bring down the size of the securities portfolio. Simultaneously, we were able to achieve solid growth in deposits. The combination of these two trends allowed us to pay down wholesale borrowings by about $2 billion in the fourth quarter. As a reminder, almost all of the wholesale borrowings are variable rate. These changes in the lower interest rate environment has allowed the cost of borrowed funds decrease 20 basis points relative to the prior quarter, and 44 basis points from the year ago period.

Turning to loan growth. Slide 13 depicts year-over-year period-end loan growth by portfolio type with the size of the circles representing the relative size of the portfolio. Municipal loan growth has been a highlight for a couple of years now. The marginal credit quality there is very good with the average new deal being about $4 million and the probability of default being relatively low. Loan growth across the enterprise also reflects our credit risk appetite and active management of portfolio concentration limits.

On Slide 14, customer related fees were up 2% from the year ago period. In certain categories, our long tenured and deep client relationships enable stable core fee income. This includes commercial account fees, card fees and retail and business banking fees. We have clear growth opportunities in certain other segments, and have been working to improve the revenue from these areas. Notably, we are seeing strength in capital markets product sales, which were up 19% from the prior year, as well as wealth management and trust fees, which are up 14% from the prior year period.

As shown on Slide 15, non-interest expense increased 12% to $472 million from $420 million in the year ago quarter, adversely impacted by the previously mentioned $37 million in severance and restructuring costs and $10 million for the resolution of an operational issue. Excluding the impact of these items, the non-interest expense reflects the ongoing efforts to reduce expenses, streamline operations and improve overall efficiency with notable reductions in advertising, credit related expense and professional and legal services over the prior year period. During the fourth quarter, we ran a full parallel allowance for credit loss process, one for the incurred loss accounting standard and the other for the new current expected credit loss or CECL accounting standard.

Slide 16 reports the results of that parallel run. We have highlighted the various changes that may impact the allowance for each of the major loan portfolios with a total estimated impact on the allowance for credit losses at the bottom of the table. Our day one impact on the allowance for credit losses was 5% reduction associated with the adoption of the new CECL accounting standard.

I might add a word of caution here. We've noted many times in the past that we expect our allowance to become more volatile under the new CECL process, as it is now subject to economic forecasts that may move materially from quarter-to-quarter. Therefore, our day one impact and the allowance for credit losses, which will be set at March 31, 2020, may be materially different.

Now I'll turn to the outlook Slide on Page 17. This is our financial outlook for the next 12 months relative to the fourth quarter of 2019. Our loan growth outlook remains unchanged at moderately increasing. Our outlook for net interest income remains slightly decreasing, incorporating our outlook of the current shape of the yield curve and our continued expectation that balance sheet growth will be more than offset by the continued trend in the portfolio.

We will continue to actively manage our deposit pricing in the lower rate environment, and this may present some upside opportunity to this outlook. Regarding customer related fees, we expect slightly increasing customer related fees a year from now when compared to the fourth quarter. Building on our prior comments related to noninterest expense, we expect the overall level of adjusted noninterest expense in 2020 to be consistent with or slightly below adjusted non-interest expense for 2019.

As a reminder, the position of elimination announced in October of 2019 will begin to impact the run rate of noninterest expense in the first quarter of 2020. Also, as we have previously disclosed, we are in the process of resolving or defined benefit pension plan, which is expected to result in a onetime charge likely towards the middle of 2020. Our outlook for adjusted noninterest expense excludes this charge.

Finally, regarding capital management. Our CET 1 ratio has declined to 10.2% from 11.7% a year ago. Our current level of capital is more than sufficient to support the risk on our balance sheet implied by our internal stress testing. Our CET 1 ratio remains above the median of our peers. We continue to believe that remaining stronger than the peer median is important.

Maintaining a risk profile, which we believe compares favourably to peers while also maintaining relatively strong positions in capital and liquidity is prudent. Therefore, we expect the capital return to shareholders in 2020 will be significantly less than it was in 2019, assuming no material change in the macroeconomic environment. Said differently, we expect our capital ratio to remain relatively stable throughout 2020 when compared to the levels reported this quarter.

This concludes our prepared remarks. Andrew, would you open the line for questions? Thank you.

[Operator]

[Operator instructions] Our first question comes from the line of Ken Zerbe with Morgan Stanley.

[Ken Zerbe, Morgan Stanley]

I guess, just to start off. I saw net charge offs jump up a little bit to $22 million. Obviously, I did not see a related increase in your provision expense. Can you just provide a little more detail on what drove the higher charge offs in the quarter?

[Michael Morris, Chief Credit Officer]

Sure, Ken. This is Michael Morris. We had one modest charge off in Q4 that drove the overall charge offs for the year. Beyond that, we saw stabilization and stronger probability of default metrics around the rest of the portfolio along with better improvement. So it was not material enough to drive increased unit sale.

[Harris Simmons, Chairman and Chief Executive Officer]

And I would say, it was not related to any other segment of the portfolio. I would characterize it -- Michael, correct me, if I'm wrong. But I would characterize it as sort of a one-off charge off.

[Ken Zerbe, Morgan Stanley]

Was there any industry or particular industry that was in?

[Paul Burdiss, Chief Financial Officer]

It's a recreation industry. And it was a $10.8 million charge off that's going to came out of blue -- we threw in the towel and locked on this large investment and we and some others took it in.

[Michael Morris, Chief Credit Officer]

As Paul noted, there's nothing systemic. It's not like we have a portfolio of these kind of loans et cetera, et cetera.

[Ken Zerbe, Morgan Stanley]

And I'll refrain from asking if it was less federally legal recreation type...

[Paul Burdiss, Chief Financial Officer]

It was very legal.

[Ken Zerbe, Morgan Stanley]

And just my follow-up question. On expenses, obviously, you took severance and restructuring charges, totally get it. It seems your guidance is still sort of unchanged or sort of already consensus, and myself are already building in sort of that modest reduction in '20 versus '19. Is that just only the fact that you adjust to your guys back in 3Q such that -- because I guess I'm just been trying to figure out like how meaningful that is going to be in first quarter when you start to see the benefit from those restructuring actions?

[Harris Simmons, Chairman and Chief Executive Officer]

Yes, the outlook is unchanged. Because as you said, we had sort of full information by the time we reported third quarter earnings towards the end of October. And so that will be -- the expense reductions that we have undertaken were baked into that outlook that we provided in the third quarter. And as it relates to run rate, we are saying kind of flat to slightly decreasing relative to full year adjusted 2019. And we're saying that, because while these reductions are allowing us to continue to make the investments that we think are important to run the business, including continuing to invest in our people.

[Operator]

Thank you. And our next question comes from the line of John Pancari with Evercore.

[John Pancari, Evercore]

On the NIM, I know you gave the comment that you expect some incremental compression here over the next couple of quarters. Can you just help maybe size that up? Is it similar to the magnitude of the compression that you saw in the fourth quarter of about couple bps? Is that the pace that we're looking for? And what's the likely driver going to be? Is it ongoing modest pressure on the loan book? Is that where the pressure is coming from?

[Paul Burdiss, Chief Financial Officer]

John, as you know, we don't provide specifically guidance on the net interest margin. We do, however, provide an outlook on loan growth and net interest income, which you see on our outlook slide. So I don't want to go further than that. I will say that the ongoing net interest margin pressure would really be related to the loan portfolio churn that I described in my prepared remarks. And also as I said the opportunity I think is re-pricing deposits. And so to the extent we are successful there, obviously -- and are able to replace our deposits lower, that'll have a positive impact.

[John Pancari, Evercore]

And then on the loan growth front, I just want to get a little bit more color around what areas of the loan portfolio do you expect to drive the bulk of the growth as you look into 2020? And more specifically regarding the municipal loan book, I know you've seen some really good growth there. What's your appetite for incremental growth here? Do you have a target size that you're willing to let that book reach? Thanks.

[Scott McLean, President and Chief Operating Officer]

John, its Scott McLean. And our growth should continue to look like the year-to-date panel that you see on Slide 22. Basically 50% to 60% coming from C&I, that's where municipal sits. And we don't feel like we're reaching any limits in terms of our municipal growth. It's been growing rapidly largely because it was coming off of very small base. But the underwriting procedures we're using and practices are highly consistent with what we've done for many, many years there we just have leaned into the area, covering more geography more densely than we have historically.

So we see continued growth in municipal. But the growth in 2020, it should look like 19 by 50% 60% C&I. We'll see some modest growth in CRE, but it would probably be low-single digits. And then consumer, I think we'll continue to see will represent 20% of our growth plus or minus. Largely -- it's largely driven by our 1-4 family and home equity businesses. I would just note on the fourth quarter being soft. The four quarters ending in the third quarter of '19 were all very strong. But if you look back prior to then, we had two to three soft quarters in a row. And so we're not especially alarmed by having a soft fourth quarter here.

[Operator]

Thank you. Our next question comes from the line of Jennifer Demba with SunTrust.

[Jennifer Demba, SunTrust]

Two questions. First, can you just talk about the operational issue you outlined in the nonrecurring items? And secondly, other than technology investments and your progress there and strategy there, could you talk about maybe the other topics you're going to focus on, on February 6th at the Investor Day?

[Scott McLean, President and Chief Operating Officer]

The operational issue, I would just describe it as, as we have wanted it was self identified. Secondly, as we continue to adopt common practices, we just saw some disparity in a certain pricing practice that we have, that we thought we really just needed to double back and create consistency over a period of time, that's all it was. The dollar amounts larger than we would have liked, but we felt like it was the right thing to do. So, no real story there other than just creating consistency in our practices across the Company relative to how we price items to our customers. And for the Investor Day, Paul, you want to take…

[Paul Burdiss, Chief Financial Officer]

Yes, I can -- at a high level. Yes, we are going to talk about technology, as you would expect. But I think the idea of this year is that we're going to talk about technology in the context of our business and really demonstrate kind of how we're going to market and where we're focusing our business, how technology is going to support that and then of course, provide an update on credit and financial outlook.

[Operator]

Our next question comes from the line of Erika Najarian with Bank of America.

[Erika Najarian, Bank of America]

So I am thinking about the outlook slide. Is positive operating leverage still possible in full year 2020? I caught in the remarks potential upside mentioned from you know potentially pulling more on the expense lever and potentially also pulling more on the deposit cost lever?

[Paul Burdiss, Chief Financial Officer]

Erika, we have not commented specifically about positive operating leverage. As we have mentioned previously over the sort of the medium and long-term that's clearly our goal. I think next year will be tough. As we outlined in slide, while non-interest income will be up net interest income is expected to be slightly down. And so expenses, with expenses sort of flat to down in that brew of revenue as I said, I think positive operating leverage will be tough to achieve in 2020.

[Operator]

Our next question comes from the line of Peter Winter with Wedbush Securities.

[Peter Winter, Wedbush Securities]

I have kind of a big picture type question. I am speaking where we are in the cycle, how you guys think about the balance between protecting the profitability ratios versus growing the balance sheet?

[Scott McLean, President and Chief Operating Officer]

I guess I'll just say that, I think it's a time where you, everybody -- you have to be just very careful. That said, we keep asking ourselves, where are we in the cycle because, I mean, this has been a very unusual cycle. It's been about as long and flat as the yield curve is, in some respects in terms of the -- it's been in a low growth for a very long period of time. And we're not seeing anything that suggests to us that anything's about to turn suddenly. We're not seeing anything systematically in our credit metrics, our portfolio that gives us any real pause. But you just know that some point we're going to see a cycle.

And so trying to -- we'll try to be careful. We certainly establish goals and targets and certainly in terms of what we'd like to see in the way of loan growth. At least starting with me, I'm pretty careful about making we had sort of a main thing around here as to hit loan growth targets. I think that's just a -- that creates a culture that's not very healthy enough in the financial institution.

Deposits is kind of different animal, I mean, you can push people when they get deposits. But loans, the nature of that game is you have to be selective. And so, while we hope to see the kind of loan growth we've outlined here expect to see it, we're going to be careful along the way. I think we have done in the last couple of years.

[Paul Burdiss, Chief Financial Officer]

I would just add to that, if you look at the loan categories that are possibly most toxic going into a decline, construction lending, as an example. Our construction loan growth has been really flat, really dating back to 2014 and before we're up may be $300 million in terms of total outstandings in construction loans from 12/14 to 12/19. We're not a big card or auto lender, and those are two places where you see a lot of challenges going into a downturn. In our leverage portfolio, as we've talked about before, compared to our peers is we are underexposed their relative to our peers. Although, you have to always watch that portfolio carefully. So those three product categories that you would want to be really concerned about if you saw a lot of rapid growth and we haven't experienced that.

[Scott McLean, President and Chief Operating Officer]

I'd just add to that, in energy, we've significantly reduced our total exposure to the services sector over the last three or four years. And so, the portfolio has in terms of its self composition has that up to 100%, but that something has become more conservative we think over time.

[Peter Winter, Wedbush Securities]

And then just on the loans. Can you give us update on customer sentiment and how it compares to maybe last quarter if you're seeing an improvement?

[Paul Burdiss, Chief Financial Officer]

I think it's, I mean, around the markets we're in its still pretty good, and maybe even getting a little better from where it was a quarter ago. I mean, we still hear concerns about labor availability and there's sort of high-class problems, if you will, as opposed to the kinds of challenges that can really hurt businesses. I think that the economy feels pretty good throughout the west.

[Operator]

Thank you. And your next question comes from the line of Steven Alexopoulos with JP Morgan.

[Steven Alexopoulos, JP Morgan]

I want to first ask you, so securities portfolio came down quite a bit in 2019 is a telegraph. So how do you think about this in 2020? Should we still expect a decline in the portfolio?

[Paul Burdiss, Chief Financial Officer]

I wouldn't expect. A lot of this kind of balance sheet repositioning, I'll call it, we really took care of it in 2019. So we are constantly looking at our kind of net liquidity position and constantly thinking about the size of the portfolio relative to size of the balance sheet, and it's really been driven by our liquidity stress testing. I don't foresee a big decline from here in the securities portfolio. But as I've said, we're in such a flat interest rate environment. We're very sensitive to the fact that the securities portfolio is not a moneymaker for us, and it's dilutive to the margin and frankly the income. And so we are managing that portfolio almost completely for liquidity at this point.

[Steven Alexopoulos, JP Morgan]

And where are new yields for new securities?

[Paul Burdiss, Chief Financial Officer]

Last quarter, we -- our average was about 245 of the securities we put on.

[Steven Alexopoulos, JP Morgan]

And then finally on expenses, as we look at the expense outlook. Does that include the anticipated benefit from eliminating the defined benefit pension plan?

[Paul Burdiss, Chief Financial Officer]

Our plan has been closed for years. And so what's happened is that it's not really for -- I've been here five years, and it's really not been -- had a significant impact on our noninterest expenses that I can think of in any given year over the last five years, because we had closed it kind of 10 years ago to new entrants and it was no longer, as I recall, accruing benefits. So this is really sort of an administratively -- this is a plan that was waning as it was. And so this is sort of an acceleration of the resolution of all the liabilities in the plan.

[Scott McLean, President and Chief Operating Officer]

And as we've noted previously, when we say that expenses will be -- this is stable to slightly decreasing, that would exclude the -- this kind of one-time expense that takes the work that's currently in [AOCI] and runs through the income statement, puts it back into equity.

[Operator]

Thank you. And our next question comes from the line of Ken Usdin with Jefferies.

[Ken Usdin, Jefferies]

Paul, if I could ask you another right side of the balance sheet question. You obviously saw a really nicely remixing into deposits and were able to lower your wholesale debt profile. First question is just how much more room do you have to remix on the right side of the balance sheet?

[Paul Burdiss, Chief Financial Officer]

Well, as we said, we reduced wholesale balance here $2 billion in the fourth quarter. So to the extent we can continue to grow deposits and those deposits are priced correctly, we can continue to change that mix. Although, my expectation is and as we said in the outlook, the balance sheet will continue to grow and the wholesale funding will be an important part of just kind of an ongoing mix. So in other words, I don't see a huge opportunity there unless we get an outsized kind of deposit growth.

[Ken Usdin, Jefferies]

Okay, and that's my second question then just related to the type of deposit growth you got and the pricing of it. Can you talk about relative to the 11 or so basis point decline you saw in interest bearing deposit costs? Or how do you see that going from here? Meaning how much more ability is there just through the pull through of lower rates versus continuing to work with customers on the downside of rates as you had on the way up? Thanks.

[Paul Burdiss, Chief Financial Officer]

Yes, I believe, we continue to have opportunity there. When you look at where deposits were a year ago versus where they are now and then you compare that to the absolute level of rates. My belief is, while we won't get deposit rates down as low as they were one or two years ago, I think we still have some room to really manage that exception pricing to continue to work that pricing down.

[Ken Usdin, Jefferies]

One quick follow-up. Just in the slide deck you mentioned the year-over-year impact of premium amortization from the SBA book. Can you talk about is that expected to continue? Or is there any outlook for changes in premium amortization in your forward outlook?

[Paul Burdiss, Chief Financial Officer]

Not a big change. On the SBA book specifically, that is just over 10% of our investment portfolio. It used to be larger that is an asset class that is declining overtime. The other artifact about that asset is that it's floating rate, and so its prime based. And so you've got the -- in that particular case when you've got kind of a floating rate asset that is experiencing prepayments in a falling rate environment, the yields on that book have been put pressure on the whole portfolio. So as I said that part of the book is a little over 10% of the investment portfolio. But when you look at the 4 basis point decline in the yield, over half of that was related to the SBA book. So that's all incorporated into our outlook and we're not expecting a big change in that trend.

[Operator]

And our next question comes from the line of Steve Moss with B. Riley.

[Steve Moss, B. Riley]

I wanted to ask about the increase in commercial NPL this quarter. Just wondering if that was driven by energy? And what are your expectations for the energy book and loan balances here going forward?

[Michael Morris, Chief Credit Officer]

I'll take that, Steve. This is Michael. The increase mostly is related to commercial loans, some oil and gas but mostly other non-oil and gas commercial, the outlook is favorable. We don't see further NPL issues for 2020. They're hard to predict, as you know. But we have, also we have quite a few non-performing loans that are actually contractually performing. So we look at the net number as well and it's positive relative to the industry in our peer group.

[Scott McLean, President and Chief Operating Officer]

On energies, do you want to -- were you asking about energy specifically, or...

[Steve Moss, B. Riley]

Yes, please Scott.

[Scott McLean, President and Chief Operating Officer]

Our commitments and our standings are well below our December 14 levels, which is really when they peak. And as Harris noted a bit ago, our exposure to services is now less than 20% of outstandings, down from about 42%, 43% of outstandings back then. And we're always watching this portfolio very closely. I think what's getting a lot of headlines is the equity markets are basically closed to upstream companies, E&P companies and to the midstream, and so that just creates a lot of sort of tension in the narrative about energy. The public debt markets and the private equity markets are open for upstream and midstream companies.

So capital is certainly flowing. And our upstream and midstream portfolios are there knock on wood. They're performing pretty well right now. Natural gas is also a really highly visible topic. Right now, pricing of natural gas will continue to be soft. It will stay in probably the sub-2 region for a bit here during the next couple of months, three to four months potentially. But that portfolio for us where we have natural gas in our borrowing basis came through the fall redetermination in pretty good shape. And we could have some criticized loans that have heavier natural gas exposure, but we think it's very manageable. So we're...

[Paul Burdiss, Chief Financial Officer]

And I think the $13 million dollar increase in non-performing loans of C&I this quarter didn't include anything with any material amount in oil and gas.

[Scott McLean, President and Chief Operating Officer]

Yes, energy nonperformings were basically flat to last quarter.

[Steve Moss, B. Riley]

And then let me may take one more crack at expenses here. The quarter included that $10 million item. Just wondering, like, is there just going to be an acceleration of the investment expense coming on that perhaps doesn't make it a little bit more constructive on the level of expenses -- the level of decreasing expenses?

[Paul Burdiss, Chief Financial Officer]

I would say that those two items are unrelated.

[Operator]

Your next question comes from the line of Brian Klock with Keefe, Bruyette & Woods.

[Brian Klock, Keefe, Bruyette & Woods]

I was just going to ask you about the capital stack. I know that you guys -- your guidance is for the overall level of CET 1 and be stable here, and you guys have returned a lot of capital over the last few years. So just looking at your capital ratios, I mean the CET 1 is still pretty strong and even your total capital ratio is very strong. And then I look at you still have the 100-basis point cushion between CET 1 and your Tier 1. So it doesn't look like you need to do anything to add to that capital stack. But it does seem like maybe that, the preferred stock, it seems like it's a little bit expensive relative to what some of your other peers have issued at. Is there anything you guys can do to make that more efficient, anything in that preferred stock part of the stack that maybe you could refinance out for something cheaper?

[Harris Simmons, Chairman and Chief Executive Officer]

We have been, Brian, you know, I think you've followed this for a while. We have been very active in kind of proactively managing particularly that preferred part of our capital stack, because we recognize it as being relatively expensive. But at this point, it would be hard for us to go out and kind of pick anything out of the open market. We really need to wait for the contractual provisions of the preferred before we can manage that any more closely.

[Brian Klock, Keefe, Bruyette & Woods]

Got it, appreciate it. Thanks for your time guys. Let's see you in a couple of weeks.

[Operator]

Thank you. And I'm so no further questions at this time. So with that, I'll turn the call back over to Director of Investor Relations, James Abbott, for closing remarks.

[James Abbott, Director of Investor Relations]

Thank you, Andrew. And thank you for joining everyone. Our next public appearance will be on February 6th for our Investor Day, as Brian Klock just alluded to. That's scheduled to begin at 10:30 am Eastern time. If you would like to attend, please contact me either by phone or by email. And we look forward to seeing you at that point in time. Thank you again for your attendance today.

[Operator]

Ladies and gentlemen, this concludes today's conference call. Thank you for participating and you may now disconnect.