Zions Bancorporation NA (ZION) 2020 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to Zions Bancorporation's Second Quarter 2020 Earnings Result Webcast. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions)

I would now like to hand the conference over to your host, Director of Investor Relations, James Abbott. Sir, please go ahead.

Thank you, Latif, and good evening, everyone. We welcome you to this conference call to discuss our 2020 second quarter earnings. For our agenda today, Harris Simmons, Chairman and Chief Executive Officer, will provide a brief overview of key strategic and financial performance. After which, Ed Schreiber, our Chief Risk Officer, will review the condition of the loan portfolio, the allowance for credit loss and the way in which we are engaging with our customers during this period of economic disruption. After Ed's comments, Keith Maio, our Chief Banking Officer, will provide detail regarding our participation in the Small Business Administration's Paycheck Protection Program as well as progress made in the mortgage banking division. Paul Burdiss, our Chief Financial Officer, will conclude by providing additional detail on Zions' Financial condition. Additional executives with us on the broadcast today include Scott McLean, President and Chief Operating Officer; and Michael Morris, Chief Credit Officer.

I would like to remind you that during this call, we will be making forward-looking statements, although actual results may differ materially. Additionally, the earnings release, the related slide presentation and this earnings call contain several references to non-GAAP measures. We encourage you to review the disclaimer in the press release or the slide deck on Slide 2, dealing with this forward-looking information and the presentation of non-GAAP measures, which apply equally to the statements made during this call. A copy of the full earnings release as well as the supplemental slide deck are available at zionsbancorporation.com. We will be referring to the slides during this call. We intend to limit the length of this call to 1 hour. (Operator Instructions)

I will now turn the time over to Harris Simmons. Harris?

Thanks very much, James, and we welcome all of you to our call this afternoon.

Beginning on Slide 3. We're about 4 months into the economic effects of the pandemic, and we felt it might be helpful to provide our assessment regarding areas of strength and areas of weakness. My summary comments here should help frame the rest of our discussion today.

I have a very strong belief that strong banks are instrumental in building strong communities. And I think the evidence of that has perhaps never been more apparent than what we've experienced during the past 4 months since the pandemic took hold. Speaking not only of our own institution, but of the entire industry, it's nearly miraculous to me that we could also quickly and dramatically alter how we work, employing technology and working from home and still deliver unprecedented amounts of aid to individuals, businesses, nonprofits, municipalities and others.

I couldn't be more proud of our team who delivered aid and volumes that significantly outpaced our market share, and they did it with grace and a singular focus on serving both customers and prospects.

One of my favorite stories from the past 3 months came from a new customer, whom we provided a PPP loan up in Idaho's Wood River Valley. This person had experienced nothing but frustration with his own banks so he tried us. The result was so satisfying that you took out this ad at its own expense in the local newspaper. It's times like these that define relationship a bank has with its customers and with its community, and I couldn't be more proud of bankers who've delivered a great deal of value in this past quarter.

Earnings were substantially lower than last year's result, primarily due to the reserve build as well as a $28 million charge associated with the termination of our pension plan. Nevertheless, adjusted pre-provision net revenue was up modestly. Our capital ratios have been a source of strength for us. We have one of the strongest levels of capital in our peer group of large regional banks. Like many other banks, we have suspended share repurchase activity until we have improved visibility on earnings. Although the expiration of our remaining warrants during the quarter, eliminated dilution in an amount equal to about 8.6 million shares as compared to the second quarter of last year.

We're excited to have acquired more than 10,000 new small business customers during the past 3 months. Keith Maio will provide more detail in a moment, but we're working very hard to do what we can to help them become a permanent part of the Zions' customer base.

Lastly, although our technology teams have worked quite effectively from home in this new environment, productivity has been moderately impacted, which will result in some likely delay in the completion of our core systems replacement project and the delivery of an upgraded mobile and online platform. But all in all, so far, we're managing reasonably well through a very challenging environment.

Slide 4 is a summary of several key financial highlights. We were generally pleased with the overall results, and we're particularly pleased with the strength of the results of our employees in helping customers obtain these PPP loans we've discussed. We've assisted just under 47,000 customers at this point, more than 1/5 of which are customers that are new to the bank. At last count, we're the ninth largest provider of PPP loan assistance in the nation. It required very long hours by thousands of employees to accomplish this task, and we sincerely thank them.

And also note that we indicated in our first quarter call that we plan to take 10% to 15% of our fees from the PPP program and make a contribution to our charitable foundation. We have determined that we'll be donating $30 million during the second half of the year out of a current total of about $220 million in total fee income from the PPP program.

The next 2 slides give a quick overview of our earnings. Slide 5 shows a time series of the bottom line result -- earnings per share results. We reported earnings per share of $0.34 in the second quarter. As noted on the slide, in the second quarter of 2020, there were several items that significantly and adversely affected the earnings per share. Most notably the provision for credit losses and the pension termination expense. Some of the prior quarters also had some notable items as you see on the slide and in the prior presentation materials.

Turning to Slide 6. Adjusted pre-provision net revenue was $300 million in the second quarter. This is adjusted primarily for the unfavorable impact of the pension termination charge and the credit valuation allowance on customer interest rate swap exposures, totaling -- the valuation amount this quarter was $12 million. You can see the outsized provisions' relative effect on profitability in the chart on the right, especially when compared with provisions in periods prior to the pandemic. We entered this economic downturn with a strong capital position. We actively managed our capital levels in 2018 and '19, but we were resolved to enter whatever downturn was on the horizon with a strong relative and absolute capital.

On Slide 7, we highlight our common equity Tier 1 capital ratio. We recognize that several of our peers have not yet released earnings unless the rankings may move around somewhat. Ours is not only strong relative to regulatory minimums, but it compares very favorably to our peers. When combined with the allowance for credit losses, we believe we're in really a very good place relative to nearly all of our peers.

I'll turn the time now over to Ed Schreiber, our Chief Risk Officer, to provide some additional detail about our credit portfolio. Ed?

Thank you, Harris, and good evening, everyone. As an overarching comment, given the depth of the decline in GDP and the increase in unemployment, the portfolio's credit quality is holding up well. We recognize that there's significant monetary and fiscal stimulus that is supporting the quality of credit, but we are nevertheless pleased with the resiliency of so many of our customers as they have adjusted for their circumstances have been able to maintain a much more stable level of profitability than we might have expected despite what has been, in some cases, large declines in revenue.

If you'll please direct your attention to Slide 8. Because of the relatively minimal credit risk with the PPP loans and because prior quarters would not be comparable, we have presented the credit quality ratios, excluding PPP loans. Charge-offs bumped up in the quarter to 25 basis points, about 2/3 of the gross charge-offs were attributable to 2 loans that have been experiencing distress prior to the development of the pandemic, which then accelerated the decline in the value of these companies. I might also highlight the time series of the chart. To help put the recession in perspective, we've included the average of those same credit ratios in global financial crisis, 2008 through 2009 and during the oil and gas downturn 2015, '16. Noted in the text, loans on deferral status reached 8.5% of loans, excluding PPP loans. Most of the deferrals are granted on a 90 to 120 days ago and have been rolling off over the course of the past month or so. Accordingly, it's too early to provide much color on the payment performance of these loans post deferral. However, the volume of redeferrals has been very modest. It's also worth noting that the revolving credit line utilization has generally returned to pre-pandemic levels.

Moving on to Slide 9. I want to reiterate the fact that Zions has generally experienced a much lower loss rate relative to nonaccrual loans than most of our peers. Like most other banks, we underwrite loans based on stressed cash flow assumptions, but we typically secure the loan with collateral. For example, real estate or other business and personal assets. We also require personal guarantees on many of our loans, and many borrowers have external sources of capital that is available to support their investment during a period of difficulty, particularly if the problem is considered to be transitory. In recent weeks, we have performed in-depth reviews of hundreds of individual credits with executive officers and credit leaders discussing the loans individually with the responsible line officers. As we perform these reviews for portfolios in more than a dozen industries that we expected to have above-average risk during this recession, we did identify a variety of situations where borrowers are reflecting initial signs of stress and downgraded a number of loans where appropriate. But on the whole, we came away from the exercise with confidence that the great majority of our clients came into this downturn with real financial strength and that our borrowers have quickly adjusted in doing what they need to do to get through this severe downturn.

Shown on Slide 10, a selected list of industries that, in our estimation, have higher risk in this economic downturn as a result of pandemic than most other categories or segments. We continue to refine this list since we initially developed it in March, the updated methodology includes industries where there was a significant level, 5% being the threshold of criticized loans. We then excluded industries that had similarly high criticized rates prior to the pandemic, with an example being an industry like agriculture, which we've talked before in other announcements, which were identified to you. At the subsegment level, we then included categories where the criticized level exceeded 10%. Previously, casinos and gaming were included, but upon further inspection, because the loans made in these segments were considerably underwritten, even by our generally conservative standards, the gaming and casino industries were removed from this growth wing. In total, these indices account for about $4.2 billion of total loan balances outstanding or approximately 9% of loans. We will continue to refine our approach regarding our monitoring of these key impacted industries and as noted, there could be movement, in or out, of industries where elevated risk exists.

On the table in the bottom right, you'll see some key performance indicators on the COVID-elevated risk portfolio versus another portfolio that has elevated risk, i.e., the oil and gas portfolio and the rest of our non-PPP loan portfolio. You can see the elevated risk industries have a much higher deferral and PPP participation rate than the rest of the portfolio. Circled in green highlight the deferral rate for this category, which is about 4x the level of the other category. You can also see substantial difference between the elevated risk category and the other category regarding PPP loans originated by Zions.

Importantly, the bottom 4 lines highlighted the collateral coverage, which is one of the key reasons why Zions' portfolio tends to experience lower levels of loss relative to nonaccrual levels, as shown on the previous slide. The elevated risk credits are 97% secured. And when secured by real estate, the median loan-to-value was 52% used with the current loan balance and the most recent appraisal. And only 3% of the loan secured by real estate have a loan-to-value ratio in excess of 90%.

Slide 11 shows the same 3 groupings and time series. The top chart shows the loan balances in columns with a weighted average risk grade shown in the 3 lines, where the elevated risk portfolio experienced a change of 2.3 risk grades in the last 6 months. Just as a reminder, on our risk rating scale, we have a 1 through 10 pass grade. The oil and gas portfolio experienced a change of 1.3 risk grades, and the rest of the portfolio experienced a change of about a half of a risk rate. It's worth noting that the probability default between grade is not linear. The probability of default for grade 10 loan, the last pass grade in our grading range, is significantly more than a grade 9, for example. The elevated risk portfolio has a weighted average risk grade of 9.2, while the other portfolio has a grade of 7.0. Loan grades shown here don't fully reflect the loss given default estimations, although the combination of the 2 is ultimately what drives the allowance for credit loss estimate.

The top right chart shows the trend in classified and nonaccrual loans, with the classified ratio being the larger number and the nonaccrual ratio being the smaller number within each bar. The stability of the other loans, which again represents the total non-PPP loan portfolio is encouraging.

On the bottom left, you can see the utilization rates of both the elevated risk portfolio and the other portfolio declined in similar number of points in the first quarter. About 3.5 or 4 points, both have fallen to levels that are actually less than the starting point, which appears to be at least partially attributable to the PPP loan balances, although it is difficult to be precise here about this.

Finally, in the bottom right, you can see the net charge-off relative to these groups.

I'll now turn the time over to Keith Maio, our Chief Banking Officer, to provide further detail on the PPP loans and the mortgage banking. Keith?

Thanks, Ed. And by way of introduction, I'm responsible for Small Business funding, mortgage and wealth management, among other responsibilities within the bank.

I'll begin on Slide 12. And as Harris noted earlier and in his quote in the earnings release, we are particularly pleased with the outcome of our efforts to play a role in providing the much-needed support to tens of thousands of small businesses. At the end of round 1 and round 2, we ranked as the ninth largest originator of PPP loans in the country, yet we're the 37th largest financial institution in the country, measured by deposits. Our share of PPP originations was 3.6x our deposit market share. This significant market share outperformance was a combination of very hard work and long hours by thousands of employees as well as superior technology. We and our PPP customers were the beneficiaries of our efforts to quickly deploy great technology and pair it with over 2,000 great bankers.

As Harris noted, but bears repeating, these efforts have provided substantial support to what now is 47,000 businesses. Within our affiliate structure, the SBA PPP loan market share distribution is generally consistent with our deposit market share.

On the right-hand side, it's important to note that 75% of these loans were less than $100,000, and you can see some statistics on the production. On the bottom, you can see some of the statistics on the more than 10,000 loans to new customers, one of which was highlighted by Harris in his earlier comments. With respect to these new customers, we're working quickly and diligently to help solidify those relationships. Each of our affiliate banks is in the midst of a new client outreach campaign, which includes compelling offers. Particularly timely with the introduction of Treasury Select, a product set specifically designed for small business. The campaigns are being augmented by external marketing efforts in each of our markets and regular communication with these new clients regarding the forgiveness process.

We believe that if we deliver an exceptional experience and retain the customer, we would likely see a significant increase of operating account deposit balances. We're only in the first inning of this retention effort, but we're optimistic about our chances. Mortgage production this year has been considerably stronger than the year ago period, certainly, some of which is attributable to the decline in mortgage interest rates, but we've also made great strides in gaining market share.

Slide 13 notes several key successes related to the rollout of our Zip mortgage. We've reduced our turn times by 25%, improving our service levels and increasing our capacity to serve more customers. Originations in the quarter exceeded $1 billion. And more importantly, an increase of more than 70% from a year ago. Loan sales income has increased nearly $10 million from a year ago period. Our pricing is comparable to that of industry leaders. We're accomplishing these market share gains through service. And we are maintaining strong underwriting criteria, the statistic of which we provided at Investor Days in the past. Ultimately, we're experiencing gains in market share that are coming as a result of the 2 factors I noted earlier: excellent employees and superior technology.

That concludes my remarks, and I'll turn the time over to Paul Burdiss, our Chief Financial Officer.

Thank you, Keith, and good evening, everyone. I'll begin on Slide 14 with a discussion of net interest income and the net interest margin. The chart on the left shows the trend in net interest income and the net interest margin and the net interest margin is in the white boxes, has fallen in the current quarter along with benchmark interest rates after a period of relative stability. Conversely, net interest income has improved by $15 million on a linked-quarter basis, reflecting balance sheet growth attributable to our participation in the SBA's PPP lending program. Notably, the $5 billion of PPP loans added in the second quarter, on average, contributed nearly $40 million to net interest income. The components of the 18 basis point net interest margin decline in the second quarter compared to the first quarter are contained in the chart to the right. Earning asset yields were down 46 basis points in the linked quarter, reflecting falling benchmark interest rates, while interest-bearing sources of funds were down 44 basis points, reflecting active deposit price management and less reliance on wholesale funding sources.

Our strong noninterest-bearing deposit position is worth less as rates fall. And the contribution of these noninterest-bearing sources of funds fell 16 basis points in the second quarter. We will continue to work to improve the spreads on loans and lower our deposit pricing where possible.

Slide 15 highlights key components of net interest income, loan and deposit growth and breaks them down by both rate and volume. The chart on the left shows average loans grew 12% over the year ago period significantly assisted by PPP loan growth as depicted with the light-shaded bar. Shifting to the chart on the right and funding, average total deposits increased 16% over the prior year period. Although much of this growth, particularly the linked-quarter growth is attributable to PPP-related deposit growth, we believe that perhaps $2 billion or more of the period-end deposit growth can be attributed to non-PPP related deposit activity. Deposit growth in this lower rate environment is consistent with past observations of customer behavior.

Turning to Slide 16. Our balance sheet sensitivity has increased as benchmark interest rates have fallen. This increased sensitivity, the changes in interest rates was driven by our deposit portfolio as deposit betas are assumed to be lower in this rate environment, and our customers are leaving more money on deposit with us. We are comfortable with the increase in rate sensitivity because we believe the risk to lower rates is limited.

On Slide 17, customer-related fees were stable from the prior year period and down from the prior quarter. Keith noted the strong growth in residential mortgage fees this year, while areas of weakness included retail fees, largely due to waved nonsufficient fund fees as we work to support our customers in this difficult environment and declines in card-related revenue and loan syndication fees due to reduced business activity. While activity appeared to improve as we approached the end of the second quarter, the economic environment remains too uncertain to predict stabilization in these trends.

As shown on Slide 18, the decline in noninterest expense reflects our ongoing efforts to reduce expenses and streamline operations. As previously disclosed, reported noninterest expense in the second quarter included nonrecurring expenses incurred in conjunction with the termination of our defined benefit pension plan. This $28 million expense included $17 million, previously reported in accumulated other comprehensive income. Adjusted noninterest expense was down $21 million or 5% to $402 million from $423 million in the year ago period. The most notable reductions versus the prior year period were in salaries and employee benefits due in large part to the reduction in positions announced in the fourth quarter of last year and lower travel, entertainment and other related items.

Slide 19 highlights the components of growth in our allowance for credit losses this quarter, which has gone from 1.08% of loans at January 1 to 1.88% of loans at June 30, excluding 0 risk-weighted PPP loans from the denominator. The provision for credit losses of $168 million, net of $31 million in net charge-offs, increased the allowance for credit losses to $914 million, as you can see on the bottom row of the chart. The 74% increase in the allowance for credit losses since January 1 reflects continued economic weakness due to the impact of the COVID-19 pandemic and ongoing stress in energy prices. While estimating the life of loan credit losses in this uncertain economic environment and, therefore, the allowance for credit losses, we considered a wide variety of economic scenarios, incorporated our own stress test results and utilized refreshed loan grades. The loan grade information has improved from the end of the first quarter when economic weakness was developing very quickly in the very last weeks of the quarter. And as a result, we had to estimate the impact on loan grade migration due to the deteriorating environment.

In summary, the second quarter was highly unusual as we dealt with operational and credit concerns while migrating nearly our entire workforce to working from home. 20% of our workforce pitched in to help 47,000 small businesses obtain much needed funding through the SBA's Paycheck Protection Program.

Through all of this, we were able to maintain some growth in pre-provision net revenue, which was helped by expense control achieved through our organizational realignment undertaken late last year. Improved revenues supported an increase in our provision for credit losses as the environment for credit became more uncertain. And the resulting allowance for credit losses, when combined with our solid capital position, supports a strong balance sheet built to weather this uncertain time.

Finally, the expiration of common stock warrants issued 10 years ago, dampened volatility in our diluted shares outstanding as diluted shares declined 5% from the first quarter.

This concludes our prepared remarks. Latif, please open the line for questions.

(Operator Instructions) Our first question comes from the line of Dave Rochester of Compass Point.

I was just wondering if you could talk about some of the bigger assumptions you baked into your CECL calculation this quarter. Any details there would be great. And if you did any kind of overlay that addressed the acceleration of the pandemic in your footprint and what that could mean for the economic backdrop or the potential for a U or W., that would be great.

This is Paul. I can start with that and then ask Ed, Michael and whoever else may want to join in to add to it. Broadly speaking, as I said in my prepared remarks, we used results from our internal stress testing to inform those results. And importantly, we used the refreshed loan grading. So these included unemployment rates that went into the double digits. And it's, I'd say, a fairly extended period of weakness. But as you can imagine, the models are just not built for an environment like this because the data set that was used to create the models doesn't create -- that doesn't include macroeconomic factors as we're seeing today. So there was also some qualitative judgment applied to the allowance process. Ed or Michael, would you add anything to that or anyone else?

Well, no, I think you covered it well, Paul. The only thing that I would add, this is Michael, is that within the qualitative, we also identified a number associated with our deferred loans where we didn't have 100% insight into the activity levels of the customer. And so that was one more element to the qualitative that we considered.

Great. And then just in terms of how you sort of integrated, any kind of outlook on the pandemic. Was there any kind of additional overlay from that perspective, just in terms of higher probabilities of a W-type recovery? Or is that not even remotely your base case at this point?

Well, the other thing I would add is that we -- as -- I think you probably heard us say, certainly, you heard Ed just say, we conducted a lot of in-depth reviews of our -- particularly the stressed part of our credit portfolio. And that was real-time information in terms of the sort of the stress and the creditworthiness, if you will, their ability to withstand loss of revenues of our customers and all of that. Very detailed information was incorporated into that allowance process.

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

Great. I guess maybe as just the first question, can you just walk us through how you guys get to a 3.14% loan yield on the PPP loans? I guess I was looking for something probably a little bit lower like maybe the 2%, 2.5% range. So this does seem a little bit higher.

Sure. This is Paul. I can give you the kind of the broad framework of how it works. As you know, the fees associated with the loans are capitalized against the loans and then amortized over the expected life of the loan. Also incorporated into that are sort of the direct expenses incurred in the production of the loans that under ASC 310 or FAS 91 as it's otherwise known as. But all these things are capitalized and then amortized over the life. And so we need to look at -- because we don't have any assumptions around forgiveness baked in here, we looked at the contractual terms of the loan. Our contractual terms happen to be a 6-month interest-only period followed by 18 months of amortization. And if you sort of capitalize our fees and amortize it as defined in the loan documents, that's where we come up with the 3.14%.

Importantly, and it says in the press release, as forgiveness does come about or these loans are repaid early, we would recognize more fee income in those quarters. As all of those capitalized net fee income gets recognized in the quarter of either forgiveness or repayment. And so my expectation is that we will see some volatility in that loan yield.

Sure. No, totally, I think -- I think we all generally understand the concept of it. I guess to get a 3.14%, and I'm asking a little more for specifics, you have the 1% loan yield. But then even assuming your average PPP fees were 4%, which would be 2% per year, that would only put your average loan yield at 3%. And then -- but you already said your average loan size was bigger than the average loan for the industry. And certainly, 4% would be at the higher end of sort of any other bank we cover. But then you minus fees, it would have to be something less than 3%. So I'm not trying to nitpick the details, but unless your average fee is 5% on your loans, it makes it really hard to get to that 3.14%, does that make sense?

Right. It does make sense. And the other -- I actually -- I sat for a couple of hours with some people proving this to me because I was where -- my head was where yours was a month ago. The answer, though, is not -- doesn't lie in the fee and the numerator, but the answer lies in the denominator because the weighted average life of the loans is much shorter than 24 months because of the amortization. And as a result, the fee ends up getting amortized over a shorter period, and so it ends up being higher than the math you just laid out. The yield ends up being higher than the math you just laid out.

And we can -- maybe James can kind of put together a numerical example of that.

Perfect. That's very helpful. I do appreciate it. And then sorry, my second question for you. I guess one of your slightly smaller bank peers just sold a large block of their oil and gas loans to a nonbank. What would it take for Zions to consider doing something similar, just given the size of your portfolio and sort of the challenging outlook for the energy industry?

Well, I'll start, and I will say, we're very comfortable with our energy portfolio. But Scott, yes, I was going to turn it over to you to take that.

Sure. Ken, this is Scott. Yes. If you really dig into what their portfolio, what they were doing, and their desire to exit the business, it's just very different set of circumstances to our portfolio. So the short answer is, there's really not a lot of similarity, and we're not thinking about selling off a portion of our portfolio to reduce the risk. They -- their exposures were pretty different than ours. And they had a more regionalized portfolio as well. I don't -- I'm not an expert on their portfolio. You'd have to really evaluate it. But when you look at the mark they took against it, it is a little eye popping, but it's just a very different fact set.

And Paul, I'll definitely follow up with James on the calculation of the PPP fees.

Great, Ken.

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

On the loan loss reserve, I know it -- the reserve totals about 1.88% ex-PPP loans. So I guess how are you thinking about the potential for incremental reserve additions here, just given the backdrop. Is this where you think the reserve should peak at this level?

Well, John, as you know, under -- in CECL land, if there is anything that we know with respect to losses, we would have had to incorporate it in this particular cycle, this alarm cycle. So the things that would add to the allowance from here are a deterioration of the credit quality of the portfolio more than we believe will already occur and/or a deterioration of the economic environment more than we have forecast. So beyond that, it's hard for me to say sort of what the direction is other than I feel confident that based on what we know today, this is our best estimate for the life of loan losses.

Okay. Got it. And then separately, on -- also on the credit side, classified loans, I know they were up sharply in the quarter, up about $600 million or so in the COVID-19 sensitive areas. And can you just elaborate a little bit more on what specific areas drove the spike there?

Sure. Michael, would you like to take that?

Sure. Yes, this is Michael. I'll take it. The big drivers are sort of the obvious hospitality, CRE retail, some commercial airline, modest commercial airline exposure. Dental drove it initially at the beginning of kind of the CECL process. We started to see dentistry recover quite quickly. Retail in itself was the driver. Gaming, casinos were drivers as well. Those are some of the industries that were the bigger contributors.

Okay. All right. And if I could just ask one more, I guess, Paul, back to you just on the reserve again. Based on your comment, if there is no change in the economic backdrop, but the charge-offs continue to come in and rise. Is it therefore, next quarter, fair to assume that we see loan loss reserve releases or the reduction in the reserve ratio?

Yes. Well, if everything progresses in accordance with our expectation, John, then I think that's probably a fair assessment, right? Because we expect adverse credit migration. We expect charge-offs. That's all baked into that $914 million number. It's really the variations in that forecast that are going to create changes in the overall allowance.

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

You said that net charge-offs were driven primarily by 2 loans. Wondering what industry those loans were in? And what kind of severities you saw?

Michael, would you like to take that?

Yes. Sure. One of the industries was leisure and recreation, somewhat of an unusual credit. The other -- we had a couple of others that were a little more modest. One was a contractor, an electrical contractor; and another was a small tech company. It was quite diverse. No systemic real trends behind it.

I think the 2 largest losses though. One was the leisure recreation that you mentioned. And the other was in retailing.

And do you know what kind of severities you saw on those credits, those 2 credits?

Well, on the leisure and creation, we saw some pretty significant severity. But it was the credit that was already troubled going into COVID. And the secondary market for, call it, not just takeouts, but private equity shrunk. And so it became even less valuable. So it was pretty high loss on that particular credit. And the retail would be characterized the same in a way because it was secured mostly by FF&E. And valuations during COVID made the FF&E just less valuable.

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

Excluding the most stressed COVID industries, I'm just curious what you're hearing from your small business customers about today's business environment?

Maybe I'll start, it's Harris. Yes. I'll take a stab at it. Listen, I think it's obviously a time where businesses of all -- are not just small businesses, businesses of all types are experiencing things that they wouldn't have -- certainly wouldn't have predicted. And there's a lot of -- there's clearly a lot of stress with a lot of smaller businesses. But it's all over the Board in terms of how they're going to get through this. And when we underwrite -- we're fundamentally a collateral lender. We underwrite to stress cash flows but take collateral as is kind of a second way out, if you will. And as we've done a lot of portfolio review, I mean, at this point, we're also seeing quite a lot of strength in a lot of businesses. They came into this with strong balance sheets. And you have to consider the fact that we came into this with the longest -- on the heels of the longest expansion that we've seen in our lifetimes. And that put a lot of businesses in pretty strong shape.

We've reviewed hundreds of credits. And I think the takeaway for us, as we came out of these reviews was, at least for me, personally, I was probably really pleased with how much strength was there, not that they're not going to have -- not that we're not going to see some -- see losses. I think the losses will be commensurate with the reserves we've set up, likely over the course of the next few quarters.

Could things get worse? Well, yes, if the pandemic continues. This is a very serious rate of infections that we're seeing and it leads to prolonged additional shutdowns. I could see things getting worse. I do think that most states, even though we're seeing this upturn in infections, a lot of businesses are figuring out how to get back to business. Places I go, I suspect this to be true for your place and things that you're seeing as well, I mean people wearing masks, they're doing the things that probably will have to be done for the next several months to allow business to carry on in this country. But I do think that most businesses came into this with -- in a pretty strong position. We see a lot of cash, certainly reflected in deposits. We've seen a lot of proceeds from PPP loans that were deposited into deposit accounts and that have remained there. I mean I expect they'll get spent down. But again, a source of strength for a lot of these businesses. So all in all, I think they're in better shape than I might have guessed, would be the case had you explained what we're going to be going through this year.

I would -- this is Scott. I'll just add to that, that I think unlike in other downturns, the banks are generally the shock absorber. In this case, I mean we all know the unprecedented level of government support. But I think what we're seeing, particularly with a lot of industries is that suppliers are providing longer terms, every -- landlords are providing flexibility. Everybody realizes that they have to help out in terms of extending payments or deferring payments and et cetera, et cetera, just to keep the process going. And so I don't think we've ever seen another period of downturn where you have this much support coming from this many directions to support small- and medium-sized businesses.

I might also just, you had one other -- one further thought. And that is as John Pancari noted, there was a substantial increase in classified loans. A lot of that coming as we went through industry after industry and did reviews on a lot of our exposures. What's as interesting to me is that as we went through those reviews, the nonaccrual numbers have not really changed that much. I mean, certainly, they're up, but they're not up commensurate with classified numbers, which is indicative of the fact that we -- yes, we think businesses are going to be experiencing some stress. But we also think there's a lot of coverage there that will not only help us get through it, but provide the basis by which we'll be able to work with our customers to get through it. So I think that's good news.

And Harris, this is Ed. Peter? My apologies, Harris, did you have any other comments?

No.

Right. Peter, just other thing, as you've seen us do before in our history in the last oil and gas downturn, we were very conservative in initially addressing the issues and we downgraded credits as we saw them. So we've followed the same methodology. And hence, all those deep reviews that are done by each of the segments. And hence the reason for the shifts were proactive in trying to be realistic about grading the portfolio.

Our next question comes from Brock Vandervliet of UBS.

Great. If we could just turn to the energy portfolio, I was curious with -- I'm assuming the redetermination process over where you see the balances going over the next year. And relatedly, where do these borrowers really make money. I know there's a lot of discussion about the hedges and the hedge performance. But as you look at your borrower base, do they need $45 or $50 oil to make money? Or are they cash flowing here?

Sure. Brock, this is Scott. I'll take that. And to start with, we have about 70-plus borrowing base redeterminations that we do. And we, for the most part, completed our spring redetermination. We have a few left to complete based on the way in which information comes in. And generally speaking, those borrowing bases because of the price volatility in the first part of the year, generally speaking, borrowing basis are down about 15%. Now remember that our average advance rate going into the quarter was kind of 50% to 60% against what a borrower could borrow. So in most cases, out of the 72, we had about 7 to 8 or 9, what we call deficiencies, which means that the amount outstanding is greater than what the borrowing base would allow. And the borrower has 2 quarters to bring their borrowing back in line with the borrowing base. And we believe with those deficiencies, and it's not unusual. We've had other periods in time back in the '15-'16 time frame, where it's not unusual to have 7 to 10 deficiencies, 10% of your portfolio with deficiencies.

And knowing these companies, as we do, we believe virtually all of them will be able to deal with it in an appropriate way. And so in terms of our upstream portfolio, we had an increase in classifieds. That's generally -- principally, where the increased classifieds came from in energy was just due to the volatility in pricing and a few more deficiencies than we would normally have. But the -- other than that, we think the portfolio is performing just fine on the upstream side.

And in terms of hedging, we're now sitting with -- about 81% of our oil production for the remainder of the year is hedged in the low 50s, about 70% of the gas production is hedged in the low 60s. I'm sorry, in the kind of the mid-2s. And about 50% of oil is hedged in '21 and about 60% of gas. So -- and principally, those numbers have gone up just simply because production has come down. The amount of financial hedges has stayed about the same, but the amount of production is less. So the hedging environment, the hedging statistics continue to look pretty good and there are strength in thinking about the credit exposure on upstream portfolios.

Your last question, I think, was about just general profitability. And what I would -- just varies by field, by area, et cetera. But generally speaking, probably 70% of the exploration that's been done in the last 5 to 7, 8 years is shale and tight sand type exploration. And you generally need $45 to $50 a barrel to be profitable with that kind of exploration. And so that's why you're seeing a rig count that's at all-time lows because they're not going to drill at these rates in the shales and in the tight sands. However, those borrowers that have a larger percentage of what is considered conventional exploration, their lifting costs are about $10 to $15 depending on the field. And so you've got to have a price down in the $20 range before historical reserves become uneconomic.

And having said that, again, the result of that is you're not going to see nearly as much exploration. CapEx budgets are being cut way back, rig count will be really low. And remember that on all of this shale-type exploration, the decline curves are about 3 years. And so production will come down significantly, and that will start to have a good impact on the amount of supply that's available, which will be supportive of higher prices.

Scott, this is Michael. Can I just add one thing, one comment to the oil and gas portfolio? It really started to correct pre-COVID, the delinquency rate on 60 days past due is only 1% on the entire book.

Okay. That's great color. I appreciate it. You don't sound like you're offside to even ex-hedges because of the price of the commodity, which is -- that's good.

Scott, this is Ed. Just one other supplement to Scott's comments. Like every other company, you have a price deck. And when we started doing the redetermination, we adjusted the price deck, right, to be more conservative. So Scott's numbers with regards in the determination and how many had that deficiency balance was actually based on a more conservative price deck. So in light of that, we still fell in line with our normal fallout even with having a more conservative price deck, just as a sidebar.

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

On the PPP program, the new customers you're acquiring, are they all in footprint? And what's your sense as to why they're going to you versus their primary bank?

Keith, do you want to take that?

Sure. I'd be happy to. I don't have the exact number handy as to what are in footprint. They're substantially in footprint. And we believe, just from anecdotal conversation with a number of them that what we've been the beneficiary of is, frankly, stress with their existing bank, stress getting their PPP loan done. I think PPP experience was all over the map with different banks. I think our experience that our customers had, as I mentioned earlier, was a good experience. It was digitally based. And so we ended up being just the beneficiary of a lot of customers that couldn't get it done at their existing institution.

Okay. That's helpful. And then for a follow up, as you talk to these customers on the PPP program, I know you're not assuming your assumptions they get forgiven. But what's your sense at this point in terms of what does ultimately get forgiven?

I'll start with that because we've started the forgiveness process, not through the SBA, but internally through our own website, our portal with some customers. And again, there's a very diverse group. I think the majority of the customers we're seeing applying for forgiveness are going to get or expecting certainly complete forgiveness. And then there are others that are expecting more in the 50% range. But we've been talking internally. Well, clearly, as we get details about statistics, as we have enough of a base asking for forgiveness, we'll have better information. But right now, we're kind of thinking it's going to be in the 10% to 15% of total balances remaining.

That don't get forgiven. That's what you're assuming?

That don't get forgiven, right, Steven, sorry.

I'll just reinforce that, that's somewhat speculative. And as Keith said, it's really early days on that.

Thanks. This is James again. We just wanted to switch over to the lightning round, as we call it, at the end of the call here. (Operator Instructions)

Our next question comes from Gary Tenner of D.A. Davidson.

Just had a question about the C&I portfolio. Obviously, most banks are -- large drawdowns in the first quarter and repayments in the second quarter, but your period end C&I portfolio kind of blew through even the year-end or year ago levels of outstanding C&I. So I wonder if you could talk about kind of the downward pressure in that portfolio.

This is Scott. I'm happy to take that. Yes, we're down about $1.4 billion versus the first quarter on C&I. And well, it'd be total loans actually. And C&I, as you know, is a big part of it. And line usage is just less, which you would expect. And the volume of request is less. So it's pretty much what you would think of in this kind of environment, which we've never experienced before, of pandemic. Everybody is sitting back. They are retaining cash. They're not borrowing. They're decreasing leverage. They're not moving forward with new activities. And everybody is in a wait-and-see mode. So we've also seen declines in the application rates that we have on all of our consumer products and our small business products, and we believe that will all come back in time. But all of it contributes to just lower total outstandings for the portfolio with C&I kind of leading the way on that.

I'll just add real quickly. I'll just add real quickly that because of the focus of our portfolio being largely small business related, and the confluence of the PPP loan program with the portfolio. I think that also had an impact on loan growth.

Our next question comes from Brian Foran of Autonomous.

I know you said lightning around, but I got this phenomenal 7-part question written down here. But on the PPP, I guess maybe the way to frame it, I've got some people e-mailing me and saying, look, this is a home run, keep customer acquisition, lower the probability of default on struggling borrowers and the NII is going to stick around for the rest of this year, maybe a little bit of next. So big positive numbers go up. And then I've got another group of investors e-mailing when you're saying: Hey, this is good, but there's the true NII run rate ex-PPP," probably more like $520 million for the quarter. And so this is kind of masking all of the low rate and other loan shrinkage that's happening, and people are going to overestimate the stickiness of NII. And I guess those aren't mutually exclusive. But for people having that debate tonight, how would you frame it? How do you see PPP overall good, because of lots of customers and everything? Or should we think about that ex-PPP NII base as maybe the offset?

Well, I'll start with that and invite my rest of the group here to join in. I really -- when you think about where our average customer lies, the preponderance of our customers are small business customers, right? And so I really don't think you can separate the PPP loan program from our loan portfolio. I understand that it's a special program. We are clearly separating it because we think it's informative for investors, but we are not separating it because we think it is sort of unrelated to the rest of the book. In fact, it's highly related to the rest of the book. So in my mind, at least, the fact that we have been able to help our communities and help so many of our customers, and bringing a lot of new customers along the way, we think, is a positive story for our organization and for the communities that we serve.

I would just -- this is Scott. I'd just add to that, too, that as part of that, whatever your assumptions are about what we'll look like when the PPP loans have been forgiven, and that story is over. And hopefully, the pandemic is starting to move into the rearview mirror, whatever your assumptions are about that, basically, our borrowers are going to have a lot less liquidity than they had going into it. They're going to be more prone to borrow. Line usage, probably goes up. And I think you're going to see a lot of people that postpone investing in things or borrowing for either personal reasons or business reasons. Once they see more clarity, you're liable to see, I don't know, a 6- to 9-month period of kind of heightened activity. So there's some assumption about growth one has to make when you come out of this as well.

Our next question comes from Ken Usdin of Jefferies.

I was wondering if you could just elaborate a little bit more on the infrastructure delays in terms of the tech implementations. What does that mean both operationally? And what does it mean in terms of expense control and the direction of costs?

Yes. Ken, this is Scott. FutureCore is our big core replacement project. We finished the first 2 phases of 3 phases on that, as you know. The third phase is our deposit phase, which is scheduled for kind of 2022. We don't think the delay is significant, either from a time standpoint or a P&L standpoint. It could certainly cost a bit more. But the relative cost of -- the relative higher cost, we believe, will be moderately small, again, in the context of what we're spending. Basically, our partner, TCS in India, they had a lot of challenges, as did everybody in that country and around the world, but they have been doing a remarkable job. And we are committed -- our team is committed to delivering on our original timing. We may have to spend a little bit more to make up for this period, and that's what Harris was trying to reference. And the period could get extended by a quarter or 2 also. But none of that would have a real material impact on what we're doing. We don't believe.

The other project is our online and mobile replacement, it was certainly -- it's being impacted by COVID, but also just the complexity of the project. And our online and mobile systems work well today. There's no real customer issue associated with that project being extended if it requires another 6 to 9 months to complete.

Latif, this is James. If we can take one more question, we're already over time a little bit and we want to let people get their evening so we'll go ahead and take one more question and then we'll take follow-ups offline.

Yes, sir. Next question comes from Erika Najarian of Bank of America.

I just made it. This question is for Harris. So you've stressed to us in anticipation of a recession that it was prudent for Zions to hold capital levels that are higher than peers. And as you've demonstrated in your results today, your PPNR is fairly solid. You've -- your reserve seems to be higher than a lot of analysts' 2-year cumulative loss assumptions. And so as we think about Zions getting through this crisis profitable and start thinking about the other side, is 10.2% still a proper capital level to hold? And at one point, do you think it's proper to move closer to peer average?

Well, I don't know. I -- good question. But I'm not sure it's a good time to be answering it because we will just -- we'll know a lot more, I suspect, in 6 months. And -- but I'll tell you, it does -- it's really kind of amazing to me. We -- nobody really saw what we're all dealing in this really weird year. But the fact that we came into it with stronger capital, feels great. And so I expect that we'll want to kind of maintain that posture. It may -- we'll have to look at relatively what that means maybe as we go through time. But I -- but it's way premature to be speculating to where we take capital ratio once we're through with this.

Latif, thank you very much for hosting the call today, and thank you to all of the investors and analysts who have joined us on the call today. If you have additional questions, please contact me, James Abbott, at the e-mail address or phone number listed on our website.

We look forward to connecting with you throughout this -- throughout the coming months. Typically, we do this in-person in conferences, but we'll be doing these things virtually for a while. And we -- again, we appreciate and thank you for your interest in Zions Bancorporation.

With that, this concludes our call for today.

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