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Edited Transcript of ZION earnings conference call or presentation 22-Oct-18 9:30pm GMT

Q3 2018 Zions Bancorp Earnings Call

SALT LAKE CITY Oct 24, 2018 (Thomson StreetEvents) -- Edited Transcript of Zions Bancorp earnings conference call or presentation Monday, October 22, 2018 at 9:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Edward P. Schreiber

Zions Bancorporation, National Association - Executive VP & Chief Risk Officer

* Harris Henry Simmons

Zions Bancorporation, National Association - Chairman & CEO

* James R. Abbott

Zions Bancorporation, National Association - Senior VP and Director of IR & External Communications

* Michael Morris

Zions Bancorporation, National Association - Executive VP & Chief Credit Officer

* Paul E. Burdiss

Zions Bancorporation, National Association - Executive VP & CFO

* Scott J. McLean

Zions Bancorporation, National Association - President, COO & Director

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Conference Call Participants

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* Brocker Clinton Vandervliet

UBS Investment Bank, Research Division - Executive Director & Senior Banks Analyst of Mid Cap

* Christopher James Spahr

Wells Fargo Securities, LLC, Research Division - Senior Analyst

* David Patrick Rochester

Deutsche Bank AG, Research Division - Equity Research Analyst

* Donald Leigh Koch

Koch Asset Management, L.L.C. - Founder, President, and Chief Compliance Officer

* Erika Najarian

BofA Merrill Lynch, Research Division - MD and Head of US Banks Equity Research

* Geoffrey Elliott

Autonomous Research LLP - Partner, Regional and Trust Banks

* Jennifer Haskew Demba

SunTrust Robinson Humphrey, Inc., Research Division - MD

* John G. Pancari

Evercore ISI Institutional Equities, Research Division - Senior MD & Senior Equity Research Analyst

* Kenneth Allen Zerbe

Morgan Stanley, Research Division - Executive Director

* Kenneth Michael Usdin

Jefferies LLC, Research Division - MD and Senior Equity Research Analyst

* Lana Chan

BMO Capital Markets Equity Research - MD & Senior Equity Analyst

* Marlin Lacey Mosby

Vining Sparks IBG, LP, Research Division - Director of Banking & Equity Strategies

* Stephen M. Moss

B. Riley FBR, Inc., Research Division - Analyst

* Steven A. Alexopoulos

JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap and Small-Cap Banks

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and thank you for your patience. You've joined Zions Bancorporation's Third Quarter 2018 Earnings Results Webcast. (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.

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James R. Abbott, Zions Bancorporation, National Association - Senior VP and Director of IR & External Communications [2]

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Thank you, Latif, and good evening, everyone, on the call. We welcome you to this conference call to discuss our 2018 third quarter earnings. For our agenda today, Harris Simmons, Chairman and Chief Executive Officer, will provide a brief overview of key strategic and financial objectives; 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 4 quarters. Additional executives with us today include Scott McLean, President and Chief Operating Officer; Ed Schreiber, Chief Risk Officer; and Michael Morris, our 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 earnings release as well as a supplemental slide deck are available at zionsbancorporation.com. We will be referring to the slides during this call.

This earnings release, the related slide presentation and 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 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 1 hour. (Operator Instructions)

With that, I'll turn the time now over to Harris Simmons. Harris?

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Harris Henry Simmons, Zions Bancorporation, National Association - Chairman & CEO [3]

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Thank you very much, James, and we welcome all of you to our call today to discuss our 2018 third quarter results.

The results of the quarter were strong relative to the year-ago results. Slide 3 is a summary of several key highlights. At a high level, perhaps most importantly, we're pleased with the strongly positive operating leverage with noninterest expense nearly flat relative to the prior year while net revenues have increased in the mid-single-digit range. Much of what we are doing is designed to push the tremendous operating leverage that we've experienced during the past 3.5 years into future years.

Loan growth was relatively healthy in a quarter that can often have a slowness due to seasonal reasons. We're encouraged with our deposit costs exhibiting a relatively low increase compared to benchmark rates. And we're encouraged with further growth in average noninterest-bearing deposits, something that's not easily accomplished when interest rates are rising.

Our credit quality profile continues to improve at a rapid rate. Remarkably, trailing 12-month net charge-off ratio was only 100th of 1 percent -- of 1 percentage point or 1 basis point. Finally, relative to the prior quarter, we increased the dollars of capital returned to shareholders. While we intend to further reduce the capital ratios to better reflect the risk profile of the company, we still have one of the very strongest capital levels within the regional bank space with a common equity Tier 1 ratio of 12.1%.

Before we dig into the numbers, within the theme of simplification and streamlining, I'd also like to note that we completed our merger of the holding company with and into the bank, reducing organizational complexity and eliminating duplicative regulatory oversight.

On Slide 4, you can see the improvement of earnings rising to $1.04 per share from $0.72 per share in the year-ago period. Although we don't provide the so-called core EPS figure, we do highlight some items that affected the earnings per share that we view as episodic or not sustainable in the long run, which are listed on the slide. Graphically, the GAAP result is the darker blue -- or the darker blue bars while the adjusted result is shown in the light blue bars.

Much of the variance is due to continued improvement in credit quality, including interest recoveries, that affect the net interest margin as well as negative provisions for credit losses. We've benefited particularly from the relatively rapid improvement in the quality of loans to the oil and gas sector. We still have some expected benefit left from that source, but we're nearing the end of that favorable impact.

Earnings per share for the third quarter of 2018 continued the trend of strong growth. By my calculations, if one eliminates the effective interest recoveries, negative provisions for loan losses and if you hold the tax rate constant with the year-ago period, our EPS growth was in the high teens relative to the third quarter last year.

Slide #5 highlights 2 key profitability metrics: return on assets and return on tangible common equity. We're happy to see the return on assets at about 1.3% even after adjusting for items and for the return on tangible common equity to expand -- to exceed 14%. We continue to work hard to further strengthen these measures, and with higher capital distributions, we expect the return on tangible common equity to continue to strengthen.

Pre-provision net revenue, as depicted on Slide 6, has performed particularly well, rising 16% over the past year and nearly doubling since we embarked on our efficiency initiative in late 2014. Adjusted for the items noted on this slide, our pre-provision net revenue increased 15% from the year-ago quarter. We have said and continue to expect the pre-provision net revenue growth rate to be in the high single digits without giving consideration to additional interest rate increases by the Federal Open Market Committee.

We're seeing momentum in several areas of revenue growth, including several areas of lending such as residential mortgage, owner-occupied properties and municipal lending, in-trust and Wealth Management and other select areas within fee income. Meanwhile, costs, both interest-bearing liability and noninterest-bearing expense, have been relatively well contained.

On Slide 7, you'll see the strong credit trends depicted on the chart on the right with classified loans declining a very strong 37% from the year-ago period and 17% from the prior quarter. Improvement in oil and gas loans was a major reason for the improvement. For the third quarter, we experienced net credit recoveries of $1 million or about 1 basis point of loans annualized. Net charge-offs for the last 4 quarters were only 1 basis point of average loans. We expect a low overall rate of net charge-offs in the months ahead, assuming current economic conditions remain generally stable.

Additionally, as you can see from the allowance ratios, we're still maintaining strong coverage of nonperforming assets and other problem credit metrics. We continue to adjust upward our qualitative factors to reflect stressors that can be observed in the economy generally such as the implementation of tariffs, higher interest rates and the effect that they may have on certain borrowers and the higher oil and gas prices, which may reduce profit margins for certain commercial businesses and drag on consumer spending, et cetera. Quantitatively, however, we have not seen a credit deterioration within the various portfolio types.

Slide 8 is a list of our key objectives for 2018 and '19 and our commitment to shareholders. We've presented this slide in prior earnings calls and at industry conferences throughout the year, so I'll avoid reading this slide to you. I'm pleased with the progress we've made on so many of these initiatives, all of which set us up to increase our return of capital to shareholders.

We increased that rate from about 20% of earnings to more than 110%. We view an increase of balance sheet leverage as appropriate, particularly given the reduction of the risk profile of the company. The decision on the magnitude, timing and form of capital return is a board-level decision, and to preempt the question, the board meets later this week to discuss, among other things, capital returns such as share buybacks and common stock dividends.

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

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Paul E. Burdiss, Zions Bancorporation, National Association - Executive VP & CFO [4]

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Thank you, Harris, and good evening, everyone. Thank you for joining us. I'll begin on Slide 9. For the third quarter of 2018, Zions' net interest income continued to demonstrate growth relative to the prior period. Excluding interest recoveries as detailed on the slide, net interest income increased $40 million to $562 million, up approximately 8%.

With respect to the revenue components, I'll start with volume and move to rate in just a moment. Slide 10 shows our average loan growth of 3.5% relative to the year-ago period. Although not listed on the slide, the period end growth in third quarter relative to the second quarter was an annualized 5% with strength weighted toward the end of the quarter. Average deposits increased about 3% from the year-ago period and increased and annualized 5% from the prior quarter.

Thus far, we've been able to achieve this growth of balances with a relatively modest increase in deposit cost. This speaks to the granularity and overall quality of our deposit franchise as we discussed in detail at our Investor Day this past March.

Examining loan growth a bit closer, Slide 11 depicts our year-over-year period-end loan balance growth by portfolio type, with the size of the circles represent -- representing the relative size of the portfolio. For most categories, we experienced solid and consistent growth.

There are 3 areas where we've experienced slight attrition: in the commercial real estate space, loan growth was adversely impacted by slight attrition in the term CRE and National Real Estate portfolios of about $240 million. Within non-oil and gas C&I loans, relative to the prior quarter, we experienced an annualized attrition rate of about 4% on our larger loans, that is loans with balances greater than or equal to $5 million, while experiencing annualized growth rate of about 4% on our smaller loans. The incremental competitive pressure on larger commercial loans seems to be coming from capital markets activity and some loosening of credit standards among competitors, including unregulated senior debt funds.

We experienced relatively consistent growth trends in 1- to 4-family and home equity loans and experienced a slight uptick in the growth rate of owner-occupied, which are generally small business loans underwritten based upon the cash flows of the borrower and secured by real estate.

Oil and gas loans have increased moderately, resulting primarily from a relatively strong increase in upstream and midstream loans while oilfield services declined slightly. Municipal loan growth has also continued to be strong during the past year. To repeat what I mentioned on last quarter's call, we've hired staff to help us grow in this area, which is focused on smaller municipalities and essential services of those cities. We've maintained strong credit quality standards and feel comfortable with the growth and expect growth to remain strong in this area.

Although we are optimistic in the near term about the growth of loans based upon the relatively strong economic backdrop, an improvement in small business loan growth and review of pipelines, we are also seeing some factors that may result in some growth pressures, including debt funds and capital markets that are highly competitive for pricing and for term, which affects our larger loans and underwriting standards that are softening within loans remaining in the banking industry, as noted in the recent additions of the senior loan officer survey; and the pricing that may not satisfy our risk-reward appetite. Therefore, we are modifying our 12-month outlook for loan growth to slightly to moderately increasing.

Slide 12 breaks down key rate and cost components of our net interest margin. The top line is loan yield, which increased to 4.71%, of which about 2 basis points are related to the previously mentioned interest recoveries. The yield, excluding interest recoveries, has increased about 40 basis points over the past year, which is a loan yield change of slightly more than 50% relative to the change in the Fed Funds rate.

Relative to the prior quarter, the yield on securities increased slightly. The shorter duration of the investment portfolio, in combination with new security purchases, which are accretive to the yield of the portfolio, helped lift the yield overall in the investment portfolio. While the premium amortization is very difficult to forecast, assuming stability in that area, we expect the yield on the securities portfolio to move higher at a moderate pace over the next several quarters and years based upon the yield of securities we are purchasing.

The cost of total deposits and borrowed funds increased 5 basis points in the quarter to 0.45% or 45 basis points, resulting in a funding beta of about 30% for the year-over-year figure. As a reminder in this case, beta refers to the change in the cost of deposits and borrowings relative to the change in the cost of the Fed Funds target rate.

The total year-over-year deposit beta was about 21% relative to the prior quarter was 29%. Cumulatively, since the beginning of the rising rate environment, we've experienced a total deposit beta of about 11%. These elements combined to result in a net interest margin of 3.63% for the quarter, which increased 7 basis points from the prior quarter and 18 basis points from the year-ago period. Excluding interest recoveries in excess of $1 million per loan, the net interest margin beta was 21% over the prior year and 26% over the prior quarter. We believe it is reasonable to expect deposit competition to intensify somewhat over the next several quarters. And if so, the net interest margin beta, if I can use that term, may be modestly less sensitive when compared to the recent quarter.

Next, a brief review of noninterest income on Slide 13. Customer-related fees increased 2.5% over the prior year to $125 million. The primary source of income that increased and decreased are listed on the page. We continue to work hard to increase our fee income, although the fees from treasury management are influenced to a degree by deposits and market rates for earnings credits applied to those balances, which in a rising rate environment create a slight headwind in our fee income trend. Similarly, the fee income realized from mortgage banking activity tends to be a little countercyclical, slowing and possibly decreasing as the economy strengthens due to the effects of higher rates on refinancing activity.

Noninterest expense on Slide 14 increased to $420 million from $413 million in the year-ago quarter. However, adjusted noninterest expense, which is just for items such as severance, provision for unfunded lending commitments and other similar items, noninterest expense was very stable at $416 million versus $414 million in the year-ago period. A portion of the increase relates to additional compensation that we announced in conjunction with the Tax Cuts and Jobs Act, which will be paid to most employees making less than $100,000 per year.

These items account for about $3 million -- a $3 million increase over the year-ago quarter. With the holding company merger in the rearview mirror, along with other items in the professional and legal line item, we experienced a slight decline in that line item, and we expect the quarterly level to remain a bit lower than it had been during the past year or so.

Also as noted on the slide, we had a onetime adjustment to our FDIC deposit insurance costs in the third quarter. Assuming the deposit insurance fund reaches 1.35% and the insurance surcharge is removed and considering our issuance of $500 million of senior unsecured debt late in the third quarter and the movement of other unsecured debt out of the holding company and into the bank as the bank and the holdco have now merged, this would result -- all of these things combined would result in a lower insurance cost relative to other secured funding. And as a result, we expect our FDIC insurance expense in the fourth quarter in all of those cases to be about $7 million.

Turning to Slide 15. The efficiency ratio was 58.8% compared to the year-ago period of 62.3%. We reiterate our commitment to achieve an efficiency ratio below 60% for the full year 2019, excluding the possible benefits of rate increases.

Finally on Slide 16, this depicts our financial outlook for the next 12 months relative to the third quarter of 2018. In the interest of opening the line up for questions, I won't read the rest of the slide to you, but we will be happy to take questions about any of these items.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Dave Rochester of Deutsche Bank.

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David Patrick Rochester, Deutsche Bank AG, Research Division - Equity Research Analyst [2]

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Just a question on capital. I mean, now that you guys are effectively out of that stock, you get more clarity and control over where capital levels go from here. I know you talked about bringing the CET1 ratio down to just above peer levels in the next 6 quarters or so. It seems like that would imply a decent step-up in the buyback going forward, especially if loan growth is maybe not a solid mid-singles in terms of growth going forward. Is that a fair statement? And any rough sense as to what that means in terms of dollars over the next year?

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Harris Henry Simmons, Zions Bancorporation, National Association - Chairman & CEO [3]

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Well, it's certainly a fair -- you've done the math appropriately, I think, Dave. I mean, we're simply reluctant to be too specific about it because our board hasn't met, and I don't want to front-run them. But it would certainly be our view that, that kind of target is still achievable, and that's the discussion that we'll be having with the board here at the end of this week.

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David Patrick Rochester, Deutsche Bank AG, Research Division - Equity Research Analyst [4]

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Okay. That's fair. I appreciate that. And then, I guess, some of your peers have talked about reducing ratios over time as well and are talking about lower levels than where they are today. And I know your discussions have talked about based on where your peer capital ratios are today. And so if we're talking about lower peer ratios over the next 6 to 8 quarters, are you guys still thinking about walking your ratios down as well versus the targets that you have been talking about over the last quarter or so, does that makes sense?

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Harris Henry Simmons, Zions Bancorporation, National Association - Chairman & CEO [5]

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Yes. So I guess, I'd answer it by saying, fundamentally, we're not going to determine what our capital ratios ought to be primarily by looking at where peers are. We're going to continue to do a lot of -- to do stress testing. We expect to do that actually probably quarterly and let that inform the discussions we're having with the board. And to the extent that the results can lead us there, that's one thing, but we're not going to be chasing peers. It's not a race to the lowest possible capital ratio necessarily. It's trying to have the right amount. And I think especially this -- where we probably should be, at least in the cycle, it's hard to know maybe where we are. Kind of in uncharted waters in terms of what these recoveries looked like. But we certainly don't want to go into a downturn in kind of behind the pack. And so that's how we're thinking about it. We're really fundamentally going to use kind of stress testing to inform how we discuss it with the board. But I think at the present time, we see enough room to get down to pretty close to where kind of the peer median is.

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Operator [6]

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Our next question comes from the line of John Pancari of Evercore.

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John G. Pancari, Evercore ISI Institutional Equities, Research Division - Senior MD & Senior Equity Research Analyst [7]

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On the loan growth front and in terms of your guidance, I know that you softened it a bit there. Can you give us just a little more clarity around what you're actually seeing that's driving you to push that lower? Like what type of competitive pressures on terms and pricing and then what types of portfolios are you seeing that happen?

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Harris Henry Simmons, Zions Bancorporation, National Association - Chairman & CEO [8]

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I'll just -- I'll give you an example and I heard just a couple of -- I was in the last week. Over in Colorado, I heard -- I was being told about a 30-year -- $30 million commercial real estate deal that went to the CMBS market. It's 10 years interest-only covenant-lite kind of deal, and it's just not -- that's not where we're going to play. And so that would be an example. I don't know, Michael, if you have any other comment about that.

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Michael Morris, Zions Bancorporation, National Association - Executive VP & Chief Credit Officer [9]

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Well, sometimes with owner-occupied, you don't really know what the industries are -- that are growing, but owner-occupied is a focus for the company. We like what comes with it in terms of ancillary business in relationships. So I think we're very pleased to see that category grow.

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Scott J. McLean, Zions Bancorporation, National Association - President, COO & Director [10]

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John, this is Scott. I'd just add that I -- the area of our portfolio or activity that's the most volatile, really, is it's the larger transactions like the CRE credit, the CRE term credit that Harris described. And we'll see it in the large energy credits. Also, we've had experienced more payoffs than we anticipated there. But generally, it's just some remaining problem credits that are paying down so that's actually a good thing. But as you know, we don't have a big exposure to larger loans, but the exposure we do have is just more volatile because of the conditions that have been described. If you look at Slide 20 though in the deck, what you see is really solid growth year-over-year and a real bright spot is our smaller affiliates in Colorado, Arizona, commerce bank in Washington and Nevada. They represent about 25% of the company and they're producing about 50% of the loan growth. So that's really a healthy thing. And as Michael noted, by loan type, owner-occupied is C&I and collectively, that's growing nicely our mortgage-related business, whether it's 1- to 4-family or the HELOC portfolio growing nicely. And then we're actually seeing some growth coming from energy again. So it's a nice mix of loans by type, and it's coming broadly across the company, particularly from our smaller affiliates.

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John G. Pancari, Evercore ISI Institutional Equities, Research Division - Senior MD & Senior Equity Research Analyst [11]

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Got it. That's helpful. Now that leads me right into my second question. I mean, given that, what can change, I mean, to get your loan growth back up here? Because obviously, given -- short of a downturn in the credit cycle, I'm not sure that the competitive environment really changes here. So if we assume that the competitive environment remains relatively intense, is there any reason to expect your loan growth can strengthen from here?

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Scott J. McLean, Zions Bancorporation, National Association - President, COO & Director [12]

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I think it's hard to know. The third quarter was a good solid quarter for us and the fourth quarter generally is a good quarter. So it's hard to know. I think the reason we lightened our guidance just a little bit is because of the volatility in these larger loan transactions. They're just lumpier. And that's I think what we were trying to say.

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John G. Pancari, Evercore ISI Institutional Equities, Research Division - Senior MD & Senior Equity Research Analyst [13]

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I get it. And we favor the better credit anyway.

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Operator [14]

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Our next question comes from the line of Ken Zerbe of Morgan Stanley.

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Kenneth Allen Zerbe, Morgan Stanley, Research Division - Executive Director [15]

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I guess, first question, in terms of your average balances on the liability side, looks like you paid down a fair amount of borrowed funds in the quarter, call it, maybe $800 million, $900 million. Can you just remind us like what that is? And should that borrowed funds stay relatively constant, just given the more moderate pace of asset growth?

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Paul E. Burdiss, Zions Bancorporation, National Association - Executive VP & CFO [16]

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This is Paul, Ken. Just -- we use that -- as you know, we use that as a balancing mechanism of the balance sheet as we think about overall kind of loan growth and what we're doing with the investment portfolio, that ends up -- and then what deposits are doing and stability and growth of deposit, that ends up being kind of the balancing component there. So that number is really just going to be, if it makes sense, kind of what it needs to be. A lot of that, as you know, our Home Loan Bank borrowing, we are becoming more active in the senior note market. You saw that issuance this past quarter. And so I would expect to see the composition of that funding change over time similar to what you saw here over the last quarter.

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Kenneth Allen Zerbe, Morgan Stanley, Research Division - Executive Director [17]

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Got you. Okay. Perfect. And then just as a follow-up question separately. Can you just remind us, how big is the municipal loan portfolio right now? And kind of what are your designs on growth in that over time?

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Paul E. Burdiss, Zions Bancorporation, National Association - Executive VP & CFO [18]

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Yes. You can see it actually on Slide -- Page 12 of our press release. Currently, municipal loan portfolio is about $1.5 billion. That's grown from about $1 billion a year ago. And we're going to continue to expect to see growth as we invest in that business.

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Operator [19]

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

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Erika Najarian, BofA Merrill Lynch, Research Division - MD and Head of US Banks Equity Research [20]

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I just wanted to ask a follow-up question to John's line of questioning. I guess, as we think about where the nonbanks aren't playing, how would you help us size your portfolio in terms of what you think is more -- a more defensible business from the nonbanks, whether it's the municipalities or owner occupied or a part of your real estate portfolio?

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Harris Henry Simmons, Zions Bancorporation, National Association - Chairman & CEO [21]

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I guess, I'd say that I think we're, relatively speaking, in a pretty good place because we have a -- significant portion of our portfolio is in generally smaller credits. I mean, we're not a big corporate banking player. So -- and even with these municipal credits, we're trying to focus on kind of smaller municipalities, where we think we can actually create a little more value for them and for us. And so owner occupied is -- and a lot of what we do there is kind of small to midsize businesses. And that's certainly true of a lot of our C&I portfolio generally. And I think those are reasonably -- it's really a pretty good place on deals that are kind of $1 million to $5 million or $6 million or $7 million, don't tend to find them their way into loan funds. They don't tend to get picked up by online lenders, et cetera. They're really -- our competitors there are largely community banks and other regional banks.

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James R. Abbott, Zions Bancorporation, National Association - Senior VP and Director of IR & External Communications [22]

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Erika, this is James Abbott. I'd add that we do have some slides in our Investor Day materials back from March that give you kind of a sense of the size of the commercial loan portfolio. So the small loans versus the medium-sized and large-sized loans, so that's a resource that you could potentially utilize. But we do have a very substantial portion of our C&I portfolio, for example, is loans that are less than $5 million in balance. And we did see very good growth out of that during the quarter, the quarter annualized a little over 4% was very strong performance, while some of the larger stuff did decline.

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Erika Najarian, BofA Merrill Lynch, Research Division - MD and Head of US Banks Equity Research [23]

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Got it. And just to follow up on the color that you provided with regards to margin expectations going forward. We're hearing you loud and clear on the deposit side. I'm wondering if you could give us a sense on what spreads are looking like right now. And whether or not sort of the lower burden as a non-SIFI changes your strategy about securities or investment?

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Paul E. Burdiss, Zions Bancorporation, National Association - Executive VP & CFO [24]

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Yes, Erika, this is Paul. So there's a lot in there. Deposit beta, we talked about, maybe don't need to get into that too much more. Loan spreads have been generally behaving, keeping in mind sort of where we operate and your conversation about kind of the average size loans. That has impacted our ability to defend loan spreads. Although I will say the composition of the portfolio has changed a little bit. So for example, if you look at our portfolio from a year ago, we had more commercial real estate relative to residential mortgage than we do today. And the spread, as you know, kind of the spread, and that's just 2 examples or maybe one combination example, but the spread is very different among those products, residential mortgage having a tighter spread. So while we're -- generally, on a deal-by-deal basis, we've had some success maintaining and defending spreads, we are seeing a slightly different composition of the portfolio, which is impacting overall loan spreads. As it relates to the size of the investment portfolio, while it's true that we're no longer subject to the LCR, our biggest constraint really is our liquidity stress testing as opposed to the LCR. So I am not forecasting or would not predict a big change in the composition of our investment portfolio because that liquidity stress testing continues to be a really important part of the way we're managing our balance sheet. So overall, as I said in my prepared remarks, we've had, if I can use the term, a pretty decent, relative to expectations, a pretty decent net interest margin beta. As you know, we've got a slide deck in the back in the appendix that provides a little more detail on the interest sensitivity, particularly the asset side of the book relative to market rates. And our performance has been very much in line with our modeling and our expectation. Looking ahead, again, considering deposit betas and other things, maybe we don't squeeze as many basis points out of the Fed tightening as we have over the past kind of 1.5 years. But we expect it to continue to -- for the modest margin expansion as the Federal Reserve continues to raise rates.

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Operator [25]

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Our next question comes from the line of Ken Usdin of Jefferies.

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Kenneth Michael Usdin, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [26]

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Just a follow-up on the deposit side. I noticed that you had good year-over-year growth, 3% and the noninterest bearings were actually quite stable. So even amidst this deposit pricing pressure we're seeing, can you just give us a little color in terms of where you're getting that incremental growth from and your continued belief in the stability, especially of that noninterest-bearing where we're starting to see that really come down in a lot of other peers?

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Paul E. Burdiss, Zions Bancorporation, National Association - Executive VP & CFO [27]

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Ken, this is Paul. I'll start and Ken or Scott can fill in. If you go back to Investor Day, we talked a lot about the composition of our deposit book and the fact that it's very granular, very operating in nature. This is -- if you think about deposits in terms of kind of operating deposits and kind of "investment deposits," our proportion of those operating deposits is actually pretty high. All that being said, the stickiness of our DDA has actually been sort of a pleasant surprise for me. I don't want that to sound negative, but our interest rate risk modeling actually anticipates that we will have more migration out of DDA than we have experienced. But I think the fact that our DDA has been so sticky is really an indication of the strength of the deposit base and kind of overall strength that, that provides to the organization.

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Kenneth Michael Usdin, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [28]

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And as a follow-up, Paul -- go ahead. Go ahead.

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Scott J. McLean, Zions Bancorporation, National Association - President, COO & Director [29]

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This is Scott. I would just add to that, that our ratio of noninterest-bearing deposits to total deposits for decades, several decades has been almost industry leading. We're sitting at 45%. Today, most of our peers are in the kind of mid- to low 30s, high 20s. But even before 2008, our relationship of noninterest-bearing to interest -- to total deposits was very favorable. And it's for the reasons that Paul described, but just to add some punctuation to that, about 65% of our $24 billion in noninterest-bearing deposits in some way touch our Treasury Management products, which just reinforces the point that these are operating balances of these businesses and they're generally smaller businesses. And what I'd suggest is, generally, these are company -- smaller companies and they're focused totally on how to enhance their gross profit margins, which may be 15% to 30% as opposed to how to get an extra 25 basis points out of their operating account.

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Kenneth Michael Usdin, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [30]

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Makes sense. And just as a follow-up to that, can you detail just is it the consumer side versus the corporate that's been growing because there's also been a lot of talk about the stickiness of consumer? Not as much of a focus for you guys but a big part of the bank it is. So what side of the bank is growing when it comes to deposits for you guys?

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Scott J. McLean, Zions Bancorporation, National Association - President, COO & Director [31]

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Mostly commercial.

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Harris Henry Simmons, Zions Bancorporation, National Association - Chairman & CEO [32]

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Yes, it's been mostly nonpersonal. So it's commercial deposits.

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Operator [33]

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Our next question comes from the line of Steven Alexopoulos of JPMorgan.

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Steven A. Alexopoulos, JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap and Small-Cap Banks [34]

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Want to start for Paul at expenses. You didn't seem to be running at the low end of the 2% to 3% range that you previously talked about. Do you think that's sustainable going forward?

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Paul E. Burdiss, Zions Bancorporation, National Association - Executive VP & CFO [35]

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Look, we are and have been really investing in our business. And I'm really proud of -- the organization has really come together. And we are creating opportunities to change, if you will, kind of the composition of the way that we're investing in the business. So we're saving money in spots and we're investing money in other spots. As we look ahead in this kind of 2019 and beyond, we're right in the middle of our budgeting process. We're very focused on expense control. We're very focused on positive operating leverage. And so yes, in the near term, I absolutely think it's sustainable.

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Steven A. Alexopoulos, JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap and Small-Cap Banks [36]

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Okay, great. And then just one other one for Harris. Given the valuation of Zions' stock here and now that you're officially out of CCAR, do you have an appetite, as we with the board -- you're the Chairman of the Board, obviously, to accelerate buybacks to get to the targets more quickly?

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Harris Henry Simmons, Zions Bancorporation, National Association - Chairman & CEO [37]

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Yes, I do, but I'm 1 vote out of 10 -- or 11 rather. So I -- it's -- again, I don't want to front run that conversation. But I think that -- I mean, clearly, valuation is one of the things we need to think about. It's the silver lining to what I'm seeing in this bank stock market these days is the fact we got a lot of capital to deal with. So it's how I'm thinking about it.

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Operator [38]

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

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Jennifer Haskew Demba, SunTrust Robinson Humphrey, Inc., Research Division - MD [39]

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Harris, just wondering if you can talk about the level of lending competition you're seeing and kind of compare and contrast that to what we saw right before the last downturn.

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Harris Henry Simmons, Zions Bancorporation, National Association - Chairman & CEO [40]

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Well, I think -- look, there's a whole lot of -- still a lot of liquidity out there, a lot of cash and it's very competitive for earning assets. I don't know quite how to compare it before the last downturn. I mean, that was -- I think, clearly, more housing kind of driven, a lot of demand for developer credit. And so -- and I think there's actually quite a lot of discipline today around that not only here but generally, what I think we see around the industry. So I think that in that respect, it's probably fundamentally different. But you are seeing a lot of -- there's been a lot of growth. You see it's not quite so much where we play is in leverage lending. But clearly, big players there. They're seeing a lot of competitive pressure from hedge funds and loan funds and others that are -- I think should be maybe some concern in terms of kind of where the next problems could pop up.

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Edward P. Schreiber, Zions Bancorporation, National Association - Executive VP & Chief Risk Officer [41]

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This is Ed Schreiber. And I want to just supplement some of Harris' comments but more importantly, look at our book. When you literally look at what we've done over the last few years, right, the balance sheet has been simplified. But more importantly, on the credit side with Michael Morris, the Chief Credit Officer and his staff, we've really designed a program in here that you've seen and exemplified through the oil and gas cycle, that we're really a big fan about positioning the company as a positive outlier through the next cycle. So if you look at -- if you really looking at forecasting, I think the way we've positioned the company from an asset quality perspective is that we're in good shape and we would be a positive outlier through this next cycle.

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Operator [42]

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Our next question comes from the line of Geoffrey Elliott of Autonomous Research.

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Geoffrey Elliott, Autonomous Research LLP - Partner, Regional and Trust Banks [43]

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First, just a little clarification. I think in the prepared remarks, you touched on the impact of the simplification of the corporate structure on expenses. Can you remind us what the benefit is you expect from that? How do you quantify that?

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Paul E. Burdiss, Zions Bancorporation, National Association - Executive VP & CFO [44]

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Yes, I didn't specifically quantify it -- Jeff, this is Paul. I didn't specifically quantify it. But what I did say, effectively, was that we had seen some escalation or elevation of professional services line over the course of the last kind of near-term and that we would expect that to -- maybe the run rate of that to be a little bit lower. That was kind of a key, I'd say the key part of the prepared remarks, I think, to deal with what you describe. And keep in mind that we did not have a lot that happened at the holding company. Nearly all of the assets and essentially all of the operations and all the employees have been at the bank level for some time. So while it does create organizational simplification, my expectation is not that we would see kind of a stepwise change in our operating kind of expenses.

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Geoffrey Elliott, Autonomous Research LLP - Partner, Regional and Trust Banks [45]

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And then on the deposit side, I guess, you're somewhat unusual in kind of operating separate brands and separate banks, if you like, in different geographies. How much flexibility is that giving you to adjust pricing in different markets? And how much variation are you seeing in competition if you kind of compare the main markets you're in?

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Harris Henry Simmons, Zions Bancorporation, National Association - Chairman & CEO [46]

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Well, we price locally. We -- the pricing decisions about deposits are made by local management teams. And they certainly have incentives to try to minimize their funding costs. But -- so we have internal transfer pricing as every large -- larger bank would have to provide -- compensate them for the funds that they're raising. They're trying to make spread on both sides of the balance sheet. I don't know what more I can say about it...

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Paul E. Burdiss, Zions Bancorporation, National Association - Executive VP & CFO [47]

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Yes. I would -- This is Paul. If I could, I would probably ascribe more value to sort of the local nature of the banks as opposed to the local brand of the banks. Your question was really around the brand, but I think the value is really around the way we're run and the autonomy of the local groups and being able to react specifically to what their client needs at a very, very local level, I think, is providing a lot of flexibility for us as we're thinking about deposit pricing.

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Operator [48]

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Our next question comes from the line of Christopher Spahr of Wells Fargo.

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Christopher James Spahr, Wells Fargo Securities, LLC, Research Division - Senior Analyst [49]

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With high single-digits PPNR, how low do you think the efficiency ratio can go?

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Harris Henry Simmons, Zions Bancorporation, National Association - Chairman & CEO [50]

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I don't know. It sounds like a game of limbo.

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Paul E. Burdiss, Zions Bancorporation, National Association - Executive VP & CFO [51]

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I'll just start out and ask Scott here to jump in, right. As I said, we're really focused not necessarily in the efficiency ratio, that's sort of the end goal. We're really focused on positive operating leverage. And if we can continue to achieve that, we are going to continue to see very strong PPNR growth and continue to grind that efficiency ratio lower.

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Harris Henry Simmons, Zions Bancorporation, National Association - Chairman & CEO [52]

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I'd make -- I would make one observation. We talked a lot about the deposit base kind in the loan mix and it is a little different than you find it in some of our peers. And it is a little more expensive to operate. And we'd hope that, that shows up in the form of the kind of deposit performance you're seeing right now. But -- so that probably creates a little bit of drag. But I think, nevertheless, we -- I hope would be that we find ourselves getting down into the kind of the mid-50s over the next couple of years. That would be just kind of generally my aspiration.

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Scott J. McLean, Zions Bancorporation, National Association - President, COO & Director [53]

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I'd just add to that. This is Scott. Going back to Steven's questions about the expense growth rate of 2% to 3%. I mean, basically, we are building our plan around that expense trajectory that we've talked about. And that involves investing actively in the businesses that we're trying to grow and investing actively in technology. And so we're not just sitting back cutting costs everywhere and not investing in the future. We've been investing heavily in the future over the last 3 or 4 years, both in terms of technology and in terms of businesses we're trying to grow with hiring new bankers and et cetera, et cetera.

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Operator [54]

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Our next question comes from the line of Steve Moss of B. Riley FBR.

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Stephen M. Moss, B. Riley FBR, Inc., Research Division - Analyst [55]

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On the loan growth front, with particular on resi and also on oil and gas, just wondering what are your thoughts for growth going forward in both those categories? And also, what are you retaining with regard to resi mortgages these days?

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Scott J. McLean, Zions Bancorporation, National Association - President, COO & Director [56]

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Yes, Mike.

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Paul E. Burdiss, Zions Bancorporation, National Association - Executive VP & CFO [57]

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Go ahead, Scott.

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Scott J. McLean, Zions Bancorporation, National Association - President, COO & Director [58]

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Go ahead, Paul -- Well, I was just going to say, our mortgage business is very different than the mortgage business you would find at the major mortgage lenders in the country. Our business is basically a private banking business although we do have a very broad consumer business also. But it basically is -- about 50% of our mortgages are for small business owners or small business owners, and I think they're going to be -- and they're generally not first-time homebuyers. So our mortgage volume is down a little bit this year versus last year but not nearly like the rest of the industry that you read about in the paper every day. So we're pretty bullish on our mortgage business. And we retain about, Paul, I think it's about 60%, 70% of what we originate. We're basically retaining everything under 10 years. And we're about to introduce a new online digital application process that we think is going to be a real game changer for us. We're not a big player, but a game changer for us. And that's in pilot right now, will be rolling out next year. And on the energy book, it's about 2.2 billion in outstandings right now. It got down to about 2 billion. Went from 3 billion to 2 billion, that was the contraction. Just in the last couple of quarters, it's grown back to about 2.2 billion. And I think 10% to 15% kind of growth in that portfolio would not be unusual at all. It's basically reserve-based lending in midstream. There's virtually no growth coming from our services business, and we've contract -- we've consciously peeled back in that area.

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Stephen M. Moss, B. Riley FBR, Inc., Research Division - Analyst [59]

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Okay, that's helpful. And then with regard to securities balances here, I know on an EOP basis, they're flat. Just wondering what are your expectations for those balances going forward?

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Paul E. Burdiss, Zions Bancorporation, National Association - Executive VP & CFO [60]

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This is Paul. I'm not expecting a big change in the size or the composition, although that may change as deposit growth ebbs and flows and loan growth ebbs and flows. But generally speaking, I expect that portfolio to remain relatively stable at this overall size.

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Operator [61]

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Our next question comes from the line of Marty Mosby of Vining Sparks.

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Marlin Lacey Mosby, Vining Sparks IBG, LP, Research Division - Director of Banking & Equity Strategies [62]

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I have 3 quick questions. One is the warrants that were outstanding were causing some dilution as stock price was going up. The share count dropped pretty precipitously this quarter. Was some of that the benefit of the kind of reversing out of some of that impact?

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Paul E. Burdiss, Zions Bancorporation, National Association - Executive VP & CFO [63]

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Some of it. But this quarter, I think if you look at average share price quarter-over-quarter, even though it maybe went up and went down, I don't know that the average is a whole lot different. I think a lot of the positive impact you're seeing there is the result of the share repurchase activity.

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James R. Abbott, Zions Bancorporation, National Association - Senior VP and Director of IR & External Communications [64]

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I think in the quarter, Marty, it's about 0.5 million shares is always the difference. Obviously, we'll have to see what the stock price does in the fourth quarter here. But if it stays where it is, it will be a more substantial improvement on the diluted shares.

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Marlin Lacey Mosby, Vining Sparks IBG, LP, Research Division - Director of Banking & Equity Strategies [65]

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Okay. And then, Paul, you were talking about the FDIC cost, and I was kind of hearing that because you had consolidated and you've done some debt, that maybe your FDIC costs are just going to go down without kind of the surcharge going away. Could you just maybe explain just the number, what it was this quarter, next quarter and what you expect it to be kind of as that rolls forward?

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Paul E. Burdiss, Zions Bancorporation, National Association - Executive VP & CFO [66]

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Yes, Marty. I probably wasn't as articulate as I could have been as I went through that part of the prepared remarks. But you're right. There are a couple of things impacting FDIC this quarter. The key one is we had sort of this incremental accrual of $3.7 million that shows up in the third quarter. But I'll go kind of -- if I can use the term, sort of a onetime thing. It's isolated event. It's not going to happen again next quarter. The other aspect is we issued unsecured debt in the third quarter. And then we had a little bit of debt that was holding company notes that have now been assumed by the bank. So as you know, unsecured debt gets very favorable treatment under the FDIC calculator. And so there's also going to be an incremental benefit of that. And that's probably going to be close to $1 million a quarter. The other big one, of course, is the FDIC surcharge. That will affect us as it affects everyone else. And just as a reminder, for us, that FDIC surcharge is a little under $6 million a quarter.

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Marlin Lacey Mosby, Vining Sparks IBG, LP, Research Division - Director of Banking & Equity Strategies [67]

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Perfect. And then the last quick question is your biggest portfolio is C&I, excluding oil and gas, and it's declining. So it's tough to see the momentum building in the portfolio with that one still kind of seeing a modest decline. Almost all of that decline back on Page 20 is coming out of Amegy. So I was just curious what was the loan type or the decisioning around because it was a big number in this quarter. But it was actually -- looks like have been consistent over the past several quarters. So just curious what was causing that decline.

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Paul E. Burdiss, Zions Bancorporation, National Association - Executive VP & CFO [68]

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I'll start, and then I'll ask my -- Scott and Michael and whoever else want to make a comment. Marty, is that thinking about -- C&I, I would also include owner-occupied in that. I think owner-occupied is a really important aspect. Just as you know, it happens to be secured by commercial real estate, but it's really sort of a commercial loan disguised as a commercial real estate loan because it's owner-occupied. But if you combine C&I and owner-occupied, there actually has been growth over the course of last year. So Scott or Michael, would you like to add anything to that?

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Michael Morris, Zions Bancorporation, National Association - Executive VP & Chief Credit Officer [69]

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No, I would echo what you said, but I would also point to Amegy's growth in owner-occupied. So there has been growth in the Texas market in C&I, and we always include owner-occupied under the C&I umbrella, as Paul mentioned.

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Scott J. McLean, Zions Bancorporation, National Association - President, COO & Director [70]

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The only thing I'd add to that is that portfolio is -- it has more exposure to larger transactions than most of our other portfolios. So -- in the C&I space. So the volatility we talked about early in the call, Amegy is a place you would definitely see it in the C&I, non-oil and gas. Exactly. Right.

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Operator [71]

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Our next question comes from the line of Don Koch with Koch Investments.

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Donald Leigh Koch, Koch Asset Management, L.L.C. - Founder, President, and Chief Compliance Officer [72]

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You sort of had a bang-up quarter. I'm just sort of flexed. I mean, it's an outstanding quarter. I'm looking at your slide from your Investor Day and your main bank is a little less than 1/3 of total bank assets. Are you finding that there is some kind of fallout? I know historically, when you do these consolidations like Regions did and Synovus and the old Barnet and UCBI, it takes several quarters for those directors to sort of come back to the family and the salary mechanism of individual banks versus one bank all working out. And I mean, can you make any statement about why you did so well in the quarter, so really outstanding but yet, the stock sort of ought to be filled.

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Harris Henry Simmons, Zions Bancorporation, National Association - Chairman & CEO [73]

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You broke up in the last phrase there, bud.

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Donald Leigh Koch, Koch Asset Management, L.L.C. - Founder, President, and Chief Compliance Officer [74]

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And why is it -- if I were to be a betting man, I would have bet that the stock in the last quarter would have certainly gone up from your phenomenal numbers. I mean, you're not going to stock-stop the ROA and the ROE, but there was that tremendous pressure -- downward pressure in the stock from this consolidation. Do you have any explanation there?

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Harris Henry Simmons, Zions Bancorporation, National Association - Chairman & CEO [75]

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Well, I don't know if it was from the consolidation. I would say it's tough enough to manage a bank without having to manage the market. I do.

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Donald Leigh Koch, Koch Asset Management, L.L.C. - Founder, President, and Chief Compliance Officer [76]

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Right. No, I understand. I know when it's a guess but are you seeing any pullout from the individuals that were part of these individual banks that you all put together?

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Harris Henry Simmons, Zions Bancorporation, National Association - Chairman & CEO [77]

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No, I mean, listen, I think the -- fundamentally, the answer is no, I mean, we had -- we have -- I mean, we got enough employees that on any given day, we got people who get picked off by others. We sometimes pick off other people's people as well. But the -- there's been -- it's been very stable kind of in the management ranks, so the company has been very stable.

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Donald Leigh Koch, Koch Asset Management, L.L.C. - Founder, President, and Chief Compliance Officer [78]

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And so they're paid the same way and the incentives are the same?

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Harris Henry Simmons, Zions Bancorporation, National Association - Chairman & CEO [79]

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Yes, fundamentally, there hasn't been a lot of change there. All of the front -- the customer-facing employees in this company fundamentally, almost all of them, not totally, but most all of them report to these local market CEOs, what we call these affiliate CEOs. And that group has been extremely stable. So I don't think that, that's -- we just haven't seen the kinds of issues you'd see going through this -- the consolidation was not a huge deal for the customer-facing people. Now it's had some impact certainly in kind of some back-office functions, places like that, but the revenue drivers, we've tried to be pretty careful about those.

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James R. Abbott, Zions Bancorporation, National Association - Senior VP and Director of IR & External Communications [80]

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This is James. I'll just jump in here. We've got just a couple of minutes left. And I would say one of the -- Harris, you've said many times at conference appearances that we made this decision to consolidate because of the feedback we were getting from the frontline employees to help make their lives simpler.

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Operator [81]

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Our next question comes from the line of Lana Chan of BMO Capital Markets.

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Lana Chan, BMO Capital Markets Equity Research - MD & Senior Equity Analyst [82]

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Just to follow up on the capital return discussion. Could you talk about your appetite for acquisitions, whether whole bank or loan portfolio or business lines?

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Harris Henry Simmons, Zions Bancorporation, National Association - Chairman & CEO [83]

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Well, I think we said for some time, you never say never. It's not something that is -- it is not a strategic priority of any sense. We'll be very opportunistic, I guess, if -- whether it's -- something was a great fit. But it's not something that we spend a lot of time thinking about.

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Operator [84]

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Our next question comes from Brock Vandervliet of UBS.

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Brocker Clinton Vandervliet, UBS Investment Bank, Research Division - Executive Director & Senior Banks Analyst of Mid Cap [85]

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Harris, I thought I heard you mention 55 or mid-50s, I guess, efficiency ratio. It doesn't seem like that would be necessarily in the near term any way top line driven. Are you feeling better about the scope for expense saves here on the back of some of the charter consolidation or vis-à-vis your improvement in terms of your regulatory situation?

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Harris Henry Simmons, Zions Bancorporation, National Association - Chairman & CEO [86]

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Well, when I talk about mid-50s, I used the word aspirational. And I'm not suggesting that's going to happen in the next few quarters. But I think -- I do think that, that's achievable with kind of our business model and with -- if the economy continues to remain reasonably healthy, I think that -- I do think that, that's -- that we'll continue to see revenue growth driven by kind of reasonable loan growth. I think we worry a little in the short run about competitive pressures on some of the larger deals as we mentioned. But that's not fundamentally what our major -- the major part of this franchise is. And so I think over time, as we continue to focus on where I think our sweet spot is, I think that's -- it's not an unreasonable kind of goal.

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James R. Abbott, Zions Bancorporation, National Association - Senior VP and Director of IR & External Communications [87]

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Okay. This is James Abbott. We appreciate -- thank you, Latif, for hosting the question-and-answer session. Thank you all for joining the call today. Please don't hesitate to contact me if you have additional questions or comments. My information is on the front of the press release. We look forward to seeing many of you at industry conferences during the balance of the year. And thank you again for your participation, and we wish you a good evening.

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Operator [88]

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Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day.