Zions Bancorporation, National Association (ZION) Q4 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and thank you for your patience. You’ve joined Zions Bancorporation Fourth Quarter 2016 Earnings Results Webcast. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference maybe recorded. I'd now like to turn the call over to your host, Director of Investor Relations, Mr. James Abbott. Sir, you may begin.

Thanks, Latif, and good evening to all of you. We welcome you to this conference call to discuss our 2016 fourth quarter and full-year earnings. Our primary participants today will be Harris Simmons, Chairman and Chief Executive Officer; Scott McLean, President and Chief Operating Officer; and Paul Burdiss, Chief Financial Officer. I'd like to remind you that during this call, we will be making forward-looking statements, although actual results may differ materially. We encourage you to review the disclaimer in the press release or the slide deck dealing with forward-looking information, which applies equally to statements made in this call. A copy of the full earnings release, as well as a supplemental slide deck, are available at zionsbancorporation.com. We will be referring to the slides during this call. The earnings release, the related slide presentation, 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. Certain of these non-GAAP measures are key inputs into Zions' management compensation and are used in Zions' strategic goals and have been and may continue to be articulated to investors. Therefore, 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 one hour, which will include a question-and-answer section. We ask you to limit your questions to one primary and one related follow-up question to enable other participants to ask questions. I'll now turn the time over to Harris Simmons. Harris?

Thank you very much, James, and welcome to all of you to join our call today to discuss our fourth quarter results. I’m going to begin on Slide 3, where we’ve some highlights for the quarter. Just note that earnings per share increased $0.60 from $0.43 per share in the year-ago quarter, a 40% increase. Also note that 25% increase in pre-tax, pre-provision net revenue that reflects our continued achievement of strong operating leverage as we’ve maintained tight expense control, while generating a 7.2% increase in adjusted revenue over last year's fourth quarter. I'll cover the rest of the key indicators listed on this page as we move through the presentation, and as well, Paul Burdiss in a little more detail. Turning to Slide 4, I am very pleased to report that for the second year of the three-year plan that we articulated back in June of 2015, we’ve accomplished all of our established goals. Financial goals were fairly aggressive. We worked very hard on many fronts to accomplish them. As we look to 2017, we're again committing to further improvement of the efficiency ratio to the low 60s. We expect non-interest expense to increase slightly in the 2% to 3% range relative to the reported figure of 2016, which is consistent with our commitment made back in the mid-2015. On Slide 5, we're pleased with the continued trend of strong increases in pre-provision net revenue, which is a result of both solid net interest income growth which as noted increased 7.1% over the fourth quarter a year-ago, and 8.1% and 5.8% improvement in GAAP and adjusted non-interest income respectively with the primary adjustments to GAAP measures being the elimination of securities gains and losses and fair value of non hedge derivative income. Both of these revenue results were consistent with our targeted objectives, although much of the improvement in the net interest income came from the growth income from the securities portfolio. And we're working hard to make changes that will cause interest income from loans to shoulder more of the burden of growth for 2017 and beyond. GAAP non-interest expense increased 1.8% and adjusted non-interest expense decreased 0.6%, respectively. All of this is resulted in this 25% improvement in pre-provision net revenue over the prior year fourth quarter as previously noted. Turning to Slide 6, we posted an efficiency ratio of 64.5% in the fourth quarter and 65.8% for the full-year. Our goal for 2016 was to achieve an efficiency ratio of less than 66%, while maintaining adjusted non-interest expense below $1.58 billion. We encourage some expenses in 2016 that were outside of our planned estimates, such as accelerated retirement benefits, elevated healthcare costs, and moderate legal accruals. However, at our Investor Day, in February 2016, I committed to you that we'd adjust the executive compensation downward if necessary in order to achieve the efficiency ratio on non-interest expense goals. And primarily as a result of higher healthcare costs in the fourth quarter, we accordingly made some modest downward adjustments to senior management incentive compensation in the quarter as disclosed further in the earnings release. But also note that we are achieving all of this while making very substantial technology investments in new core systems and related projects. We will continue to work hard beyond 2017 to identify additional opportunities to become more efficient. Moving to Slide 7, we experienced soft loan growth in the fourth quarter due in part to constraints on growth in our commercial real estate portfolio as a result of internal concentration limits and continued attrition in oil and gas loans, which declined more than a $150 million in the fourth quarter and more than $460 million over the year-ago period. We're optimistic that we'll see improved growth as we move through 2017. Before I leave Slide 7, it's worth noting that we did experienced very strong deposit growth in the fourth quarter. Some of this is seasonal and include some large deposits by a small number of customers and we’ve already seen substantial reversal with some of that spike in deposit growth in the first quarter -- we’ve seen some reversal in the first quarter. Slide 8, depicts the credit quality metrics of about 95% of our loan portfolio, but exclusive of the oil and gas segment which is about 5% of our total loan portfolio. We've historically had strong credit performance in our loan portfolio and we're determined to be a strong performer relative to the industry in the next credit cycle. We don't currently see significant problems developing in any of our markets. Overall credit quality results were relatively consistent with those we reported in the prior quarter with a slight increase in non-performing loans and classified loans, but a decline in criticized loans. Net charge-offs in the portfolio, excluding energy loans were less than $1 million for the full-year on a portfolio with an average $39.6 billion. We nevertheless recognize that it's unlikely that every year will be as pristine as 2016 was for this non-energy segment. So we're incorporated -- incorporating into our outlook some modest increase in losses for 2017. Slide 9 is the depiction of the credit metrics for the oil and gas portfolio. We are becoming more optimistic about the outlook for losses and problem credit levels over the next several quarters as we're seeing some favorable indicators both within our portfolio and in the industry generally. The metrics took a decisive turn for the better in the fourth quarter. Relative to the prior quarter, criticized, classified, and nonaccrual oil and gas loan levels declined 16% to 11% and 15%, respectively. As a result, we feel comfortable, modifying our outlook on provisions for the next four quarters to a level somewhat lower than what we’ve reported for 2016. With that overview, I'll turn the call over to Paul Burdiss, our Chief Financial Officer to further review the financial results. Paul?

Thank you, Harris, and good evening, everyone. I'll begin on Slide 10. For the fourth quarter of 2016, Zions reported net earnings applicable to common shareholders of $125 million or $0.60 per share. That's up from $0.43 per share in the year-ago period. We highlighted pre-provision net revenue, which increased 25% from the year-ago period as Harris discussed. I'll also draw your attention to two key big picture profitability measures. First, return on assets has increased to 89 basis points, up from 68 basis points in the year-ago quarter. Return on average tangible common equity increased to 8.4% from 6.2% in the year-ago period. We are committed to improving these measures of balance sheet profitability over the next couple of years and we are certainly encouraged by the recent improvement. The last item highlighted on this page is the efficiency ratio, which Harris already discussed in some detail. I'll make a few comments about revenue first [ph]. About three quarters of our revenue comes from net interest income driven primarily by loan and securities growth, coupled with solid customer related funding. Slide 11 is a graphical depiction of our loan growth by type relative to the year-ago period. As a reminder, the size of the circles represent the relative size of loan portfolios. We experienced 6% growth in non-oil and gas, commercial and industrial loans. However, in the fourth quarter, these increased by about 1.7% on an annualized basis which we acknowledge as disappointing. As we had discussed in previous calls and at investor presentations, we expect growth in commercial real estate to be moderate going forward and indeed in the fourth quarter relative to the third quarter CRE loans declined about 1% with the primary driver being our commitment to hold fast to our portfolio concentration limits. We achieved 9% year-over-year growth in both 1-4 family mortgage and home equity loans, which is consistent with our desire for stronger growth in these portfolios. Such loans increased at an annualized basis of 7% and 10% from the prior quarter levels, respectively. We expect non-oil and gas commercial and industrial, and residential mortgage loans to be the primary drivers of overall loan growth. We continue to expect a modest decline in the national real estate group loans and oil and gas portfolio loans. Although we expect a decline in 2017 from both portfolios to be less than that experienced in 2016. Slide 12 outlines the recent trend in net interest income, which continued to demonstrate growth in the fourth quarter. On a year-over-year basis, net interest income was up 7.1% when compared to the fourth quarter of 2015, driven primarily by a $5 billion increase of the investment portfolio …

In the average balance.

… in the average balance of the investment portfolio, thank you. Interest income from loans increased $8 million over the prior period or 1.9% increase. While average loan balances were up $2.3 billion or 5.7%, the yield on loans declined 13 basis points from the year-ago period. The decline in the loan yield was due to a change in the composition of our loan portfolio which migrated toward modestly lower yielding loans such as residential mortgages and also due to a decline in income from purchase credit impaired loans. As shown in the box at the bottom right of that slide, Page 12, we remain positioned to benefit from rising rates. However, during the past two years, we have deployed a substantial amount of cash into highly liquid fixed-rate securities which reduced our interest rate sensitivity somewhat using the midpoint of the range shown a 25 basis point increase in the yield curve -- across the yield curve would produce approximately $20 million of additional net interest income annually, all else equal, including the size and composition of the balance sheet. It will take a few quarters for the impact of a short-term rate increase to be substantially recognized, as only about half of our loan portfolio is indexed to short-term LIBOR or prime. Slide 13 provides additional information regarding our active management of the investment portfolio. We accelerated the purchases of high-quality liquid securities during the fourth quarter, increasing the securities portfolio by $3.2 billion. We expect to continue to purchase securities at similar pace through the first quarter of 2017 and we will continue to evaluate the company’s interest rate risk profile as one of two key drivers of the size of the investment portfolio. The primary driver being the need to have substantial on balance sheet liquidity. As a reminder, the size of the securities portfolio is not constrained by the level of cash on the balance sheet. We continue to exercise caution with respect to duration and extension risk. The mortgage-backed securities we are adding have a duration of about four years with a duration extension risk being only about half a year if rates were to rise by 200 basis points. The duration of the entire securities portfolio including floating rate SBA securities, is about 3.2 years today. If rates were to rise 200 basis points across the curve, our models indicate that the duration of the portfolio would not change to any significant degree which is attributable to our discipline in purchasing MBS with limited extension risk and because the floating rate small business administration securities held in the portfolio are expected to prepay at a faster rate as the economy strengthens and rates rise. Another key component of net interest income, the rate or yield of the investment portfolio and the loan production can be found on Slide 14. This slide breaks down key components of our net interest margin. The top line is loan yield, which was stable from the prior quarter at 4.11%. Income from loans purchased from the FDIC in 2009 was essentially unchanged relative to the prior quarter. The securities portfolio yield increased slightly this quarter attributable to reduced premium amortization as compared to the prior quarter due largely to a steeper yield curve. Our cost of deposits did not change relative to the prior quarter. Turning to Slide 15 and noninterest income, total noninterest income equaled $128 million, up from $119 million a year-ago, which is roughly consistent with our targeted objective, but down from $145 million in the prior quarter. There were a couple of items worth noting that cause the decline from the prior quarter. First, in the prior quarter, you may recall, approximately $11 million of that income was attributable to strong valuation performance of a publicly traded company held in the Zions small business investment company portfolio. And we said at the time that we do not expect that income to recur or at least not regularly recur that source of income or loss as was the case this quarter is found in both the dividends and at the other investment income line items and in the equity securities gains and losses line item. Secondly, the fair value and non-hedged derivative income line increased $7 million in the quarter, most of which was attributable to changes in the interest rate environment which cause customer related swaps to experience a mark-to-market increase in value. Finally, loan sales and servicing declined from the prior quarter due in part to adverse valuation marks on mortgage loan rate lock commitments. This was about $2 million of contra revenue in the fourth quarter compared to $1 million of positive revenue mark in the third quarter. Noninterest expense on Slide 16 increased 1.8% from the prior year, and if adjusted for items such as severance as displayed in the GAAP to non-GAAP table at the back of the press release and earning slides, noninterest expense declined 0.6% from the year-ago period. During the quarter, we experienced some expense that was not fully anticipated. However, as Harris noted in his earlier remarks, elevated fourth quarter noninterest expense directly resulted in management incentive compensation that was $5 million less than planned in the fourth quarter. As detailed on the slide, we expect total adjusted noninterest expense to increase between 2% and 3% in full-year -- fiscal year '17 -- full-year '17 when compared to full-year 2016 results. It's worth reminding everyone that there is seasonality to noninterest expenses, particularly with regard to the first quarter compensation related items. On Slide 17, is a list of our key objectives and our commitment to shareholders. We are fully committed to achieving positive operating leverage and we believe at this point with more than 20% year-over-year growth in PPNR, we can declare that our actions are making a noticeable difference. We are committed to the substantial simplification of our operating process -- processes. We continue to work hard to upgrade our technology systems which we expect will result in an improved loan and deposit and customer information infrastructure. When complete, this information should simplify our back office, provide additional data on a real-time basis to our bankers and customers and better enable us to adopt enhanced digital capabilities. Regarding the capital with which shareholders have entrusted us, we are targeting much more substantial returns on capital than what we’ve seen today, and we are tracking towards those goals as discussed earlier. Regarding returns on capital, we are pleased to have made progress and returning more capital to shareholders. Of note, we have repurchased nearly 3 million shares or about 1.4% of shares outstanding at June 30. Although it is premature to give specific guidance on our expectations for CCAR 2017, the results of our internal stress testing indicated that we have an opportunity to optimize our capital position to be more reflective of the manageable risks in the Company. Finally, we are absolutely committed to our history of doing business with a local community bank approach. Slide 18 depicts our outlook for the next 12 months relative to the most recent quarter. We are maintaining our outlook for loan growth at moderately increasing, which could be interpreted as an annual rate of growth in the mid single-digit range. We continue to expect net interest income to increase in the mid to high single-digit range, driven primarily by loan and investment securities growth. No additional rate hikes are assumed in this outlook, although additional increases in short-term rates are expected to improve net interest income. Turning to the provision for credit losses, we posted a provision of less than $1 million in the fourth quarter, which includes the provision for both funded and unfunded loan commitments. So while we have the word increasing to describe the outlook for the next four quarters relative to the fourth quarter, we are increasingly optimistic that the credit deterioration we experienced from the oil and gas portfolio has turned the corner. As Harris mentioned earlier, we don't think that 0.2 basis points of net charge-offs on the non-oil and gas portfolio for the full-year 2016 is sustainable. So as energy credit costs decline and we experienced a reduction in the reserve on that portfolio, we may experience a slight deterioration in the rest of the loan portfolio. When combined with provisions for our new loan growth, we feel comfortable with our outlook for a total provision expense including both funded and unfunded loans, of something similar to that which we experienced in 2016. We expect the customer related fees, which are defined in our press release and exclude dividend income and securities gains and losses, should increase moderately from the level reported in the fourth quarter. We currently expect adjusted noninterest expense to increase in 2017 between 2% and 3% relative to the 2016 reported levels. We expect our effective tax rate to be in the 34% to 35% range in 2017 barring any meaningful changes in the tax code. We expect preferred dividends to be approximately $40 million in 2017. And as mentioned in my remarks earlier, we do anticipate redeeming up to $144 million of higher cost preferred equity in the first half of 2017. In light of the recent increase in our share price, this is a new outlook item that is diluted shares. Zions stock appreciated from an average price near $30 in the third quarter to a current price in the low 40s. As you are likely aware, we’ve approximately 35 million warrants outstanding. 5.8 million TARP warrants and 29.3 million warrants issued in 2010 to supply common equity capital to the Company at that time. The warrants have a strike price of around $36. The exact details and link to the prospectuses for those warrants are provided on our Web site under the warrant information link on the homepage. As the average stock price rises and the weighted average strike price above the weighted average strike price, warrants increased diluted shares outstanding and are therefore dilutive to earnings per share. We’ve identified in the appendix that Slide 21, which provides a view of the approximate dilution for each dollar movement in the average share price. If the stock price would average in the first quarter near where it is today, we would expect the diluted share count to increase to approximately 210 million shares which is net of the share repurchase -- purchases we anticipate in the first quarter. This concludes our prepared remarks. Latif, would you please open the line for questions. Thank you.

Yes, sir. [Operator Instructions] Our first question comes from John Pancari of Evercore ISI. Your question please.

I just want to ask about the efficiency ratio expectation. I know you’re indicating your -- reiterating your commitment to the low 60s level for 2017 and that you came in around 65% ballpark for '16. And getting first that low 60s, can you just give us an idea of what that would interpret into? Is that a good way to think of it 60% to 63%, is that a fair assumption?

Well, I think -- yes, clearly those numbers are in the low 60s. We’re not going to give a knife edge kind of number in part, because we think we're getting to a place where we’re going to be competitive in the industry. And low 60s isn't where we want to stop, I'll also say that. This isn't about trying to find a floor. But we also want to -- fundamentally I’m wanting to be a little cautious about creating such a focus on that number that it could lead to perverse kinds of behaviors in the Company. We’ve seen what incentives can do to cultures recently and I just don’t want to have anything that's going to tip anybody over the edge in terms of doing something unnatural. So I am going to leave it kind of at that, low 60s is what we said we do a year and a half ago and that's where we intend to be. You will all have to judge whether we meet your expectations as to what that number means, but that’s the reason for it.

Okay. Yes, what I was getting at is that, if it is let's call it 63% the high end of that, that’s 200 basis points of improvement off of this year without any incremental assumed Fed hike. So, I guess what I’m getting at is, where does that come from without the help of the Fed?

Well, you do have the Fed hikes that we had in December we anticipated that we were quite clairvoyant back in June '15 and understanding that the Fed was going to do that in December. As you recall, we had actually basically assumed that we would have one in December of '15 and one in December '16, which I think makes us more accurate than the Fed has been. But beyond that, we still have room for some securities growth. We expect we will see some resumption of some loan growth, and there will be a lot of continued focus on expense management. So anyway, we thought hard about the budget for this place, and it gets us to the place we think we need to be and we think it's doable.

I would just -- this is Scott, John. I would just add to that that the fundamentals that we laid out in that June 1 2015 announcement as Harris notes about the repositioning of cash, loan growth, fee income growth keeping expenses flat and the term we have used for 2017 back then was slightly increasing in 2017. All of that without rate increases just like in '16 …

Yes, beyond what we plugged in.

What we had plugged in, right. The two rate increases that we’ve plugged in December of '15 and '16. All of that just like we saw in '16, should allow us to continue to improve the efficiency ratio in '17.

Okay, great. All right. Thank you.

Yup.

Thank you. Our next question comes from Erika Najarian of Bank of America. Your question please.

Hi, good evening.

Hi, Erika.

My question is on the CCAR. So there has clearly been a lot of momentum even before the election to raise the definition of a domestic SIFI from $50 billion to $250 billion. And I’m wondering if that happens, other than obviously returning more of your excess capital to shareholders, is there anything strategically that you are doing now that is dictated by CCAR and previous CCAR results that you may be doing differently? And I guess maybe I’m specifically thinking about, you talk about moderate growth in C&I and CRE, and I wonder how much of risk management is -- the regular prudent risk management that Zions management is used to executing versus something more stringent that is attributable to the current regulatory environment?

I guess -- let me take a stab at giving you my point of view. This is Harris. I think that as we talked about concentration limits for commercial real estate, I think we have made some changes during '16, particularly around multifamily as we have been -- became increasingly concerned that the rate of growth and that product type was not sustainable across the economy, and -- but more generally commercial real estate as a category is something that we are trying to be very prudent about. We are seven or eight years into a cycle, and while we don't see anything that -- I mean I actually think it's been a pretty responsible cycle. This credit behavior goes by peers and by what we see out in the marketplace. Nevertheless, I mean, we are deep into a cycle and so we’re going to be careful about that. But I would say CCAR creates uncertainty that may incrementally create a little more caution here than we'd otherwise have. So we wouldn’t -- we wouldn’t don't want to behave recklessly. If we are not subject to CCAR I don't think it's going to change our behavior in any material way, but it probably gives us one last thing to be concerned about if you, because it's been such a precipitous. Now you get it wrong, it was -- it became kind of a nuclear event as we saw back in 2014. And so, that would be obviously welcome. We’ve expressed before, we don't think that the Federal Reserve's levels are really built for a regional bank like ours. We think we have a different balance sheet mix and we think we would very much like to be able to use our own models that would continue to have regulatory oversight to help us think about risk appetite and the tolerances we have. And so, being relieved of the SIFI status would certainly be helpful in that respect. So I hope that's helpful. But it's not that we would -- you wouldn't see wild abandon here.

That was helpful. Just a follow up to that, how do you think if the SIFI buffer was raised, your expenses can potentially progress or is there any low hanging fruit in the regulatory side that could potentially be reinvested or go away your thoughts on that.

Well, I think a lot of the expense was in building the framework and models. And there is clearly some cost to maintaining them to keeping them current, and I don’t expect that we are going to jettison that framework. It's what we are using to run the Company today. But there are things, including for example the resolution plan, the annual cadence of this will become a little less expensive. So I think again, incrementally it would help. It would have been really helpful if we had this for years ago before we invest a lot of money in creating incredibly comprehensive modeling capability. So I expect that we go to a maintenance mode more than a continued investment mode in all of this. And that would be helpful, but it's not going to be a material big step change, if you will.

Got it. Thank you.

Thank you. Our next question comes from David Eads of UBS. Your line is open.

Hi good afternoon.

Good afternoon.

Maybe -- could you talk a little bit about kind of the direction or the pace of bringing down the asset sensitivity, you talked about it. We can see it coming down this quarter, and I guess it seems like you are going to continue adding more securities and then obviously adding the mortgages on the balance sheet. And I guess, when we think about what the limiting factors you guys looking at? Is it kind of the average of the sensitivity in the slow and fast deposit beta [ph] scenarios or is it certain amount of two another rate hike. How do you guys think about that?

Well, this is Paul, David. We have an [indiscernible] committee that meets on a regular basis, so we consider balance sheet sensitivity in the context of the shape of the yield curve and kind of the return that we can earn or that we might be leaving on the table as it relates to the -- relative size of the duration of the asset and liability side of balance sheet. So I wouldn't say explicitly that there is a target other than to say in the past we’ve been as you know very, very asset sensitive. And we have been bringing that down over time. I think it's the view of the committee that we will continue to work that down. As you know, cash and securities aren't the only way to do that. I mentioned in my prepared remarks that while we continued at a pretty good pace of adding securities in the fourth quarter, that's going to continue likely through the first quarter, but after that if the committee chose to we can continue to work down that asset sensitivity through interest rate swaps to the extent that the shape of the curve looks attractive on the balance sheet. I will say historically the other thing I should note is that historically we have published a fast and a slow asset sensitivity. I think moving forward as we get into 2017, we are probably going to be publishing one baseline number and then probably publishing some sensitivities around that. So rather than having kind of the guardrail of the fast and slow, we’re going to provide more of a maybe a midpoint estimate for lack of a better term, and then provide sensitivities around that, which we think will be just as valuable or perhaps more valuable to investors.

Okay, very helpful. And then, maybe looking into 1Q, you talked about the loan mix kind of resulting in a flat yield or average yield on loan, presumably we should see more of a benefit from the December hike in 1Q results and probably that would offset the mix shift there, but maybe the upside is less than what we saw from the hike from a year-ago? Is that all kind of reasonable in thinking about 1Q?

Yes, I think so. It should be. I would expect it should be roughly comparable to what we saw last year. You are right about the mix shift and you are right about the timing. The rate increase income to the end of the year, we got a lot of things that kind of replace in the next month or quarter after that. So you’re going to see that work in the first and second quarter. And it should be roughly consistent in terms of margin pick up. I believe to what we saw last year.

Yes, the only thing, David. this is James. I'll just jump in. The last year we had a large headwind from the income from purchase credit impaired loans are the ones we bought from the FDIC in 2009 and that we still have some income from that, but it's pretty small compared to where it was in the fourth quarter of '15. So there is less headwind to work through there. So you might see it shine through a little bit more this time around.

Hi, guys. Great color. Thanks

Thanks, David.

Thank you. Our next question comes from Dave Rochester of Deutsche Bank. Your line is open.

Hey, good afternoon, guys.

Hi.

Just back on the NIM discussion, it just seems like there are a lot of moving parts there for the NIM in the first quarter with a lot of support, you've got the cash going to securities, the decline in securities premium NIM, the rate hike, anyway you could frame what you expect the benefit will be overall for the NIM in 1Q and then just based on your assumptions you’ve for the year I’d imagine you are thinking NIM expands through 2017, but probably has the biggest move up in 1Q, is that fair?

Well, a couple of things. I can't be any more specific around kind of a point estimate for net margin in the first quarter. You correctly point out that there is a lot of countervailing influence is there. The repricing of the SBA bonds for example, much slower premium amortization on some of the fixed rate MBS. We've got -- while we are not seeing spread compression necessarily in the loan portfolio, we are seeing a continued change in the composition of loans, which have the effect of reducing the overall loan yield. That’s kind of a headwind and as you point out a tailwind is the rate increase. We are also expecting -- my expectation is that we will be able to maintain deposit rates close to where they are at. That's going to be kind of a heavily competitive driven situation. But my expectation is at least for now we are going to be able to maintain that. So that your point there's a lot of things that obviously impact the net interest margin. On balance, I expected to be a little higher in the first quarter. As we move throughout the year it's hard to see with absolute clarity whether or not the gain that we are picking up from the rate increase this quarter is going to -- is going to be offset by those continued composition changes in the loan portfolio. But I would expect as we have seen over the course of last year, I'd expect that NIM to continue to be quite strong.

Then are you assuming any further curve steepening in your assumptions? I mean, you’re talking about number rate hikes, but what are the steepening, I missed that part.

I’m sorry, the question was about the impact of steepening?

Yes, it is in terms of your NII assumptions, your estimate for NII growth. Are you assuming any additional curve steepening to what we’ve already seen? And then I know you’ve said no more rate hikes, so I was just wondering about additional curve steepening [indiscernible]?

Yes, sorry. Our balance sheet is very sensitive to the short end of the curve, so that would not necessarily change the outlook. Another point though that is worth mentioning, I mentioned in my prepared remarks that the security purchases are not dependent upon cash available on the balance sheet. Obviously what that implies is to the extent we buy bonds beyond the cash that's available on the balance sheet, we are incrementally funding those. And so the marginal benefit, if you will, would be lower on those incremental purchases than what we've seen over the course of the last 18 months, because of that point you are no longer replacing cash with securities, but you are actually going out and funding those. So it's kind of yet another complexity as you think about net interest margin and the outlook there.

Yes, that makes sense. I guess, I was thinking about securities reinvestment rates going up over time and it seems like you're going to be having a lot more in the way of purchase activity there. I was just wondering where purchase rates are today overall? I know you're buying a lot of different types of securities, but …

Yes, we are. Overall it's probably a little over 2 -- kind of between 2 and [indiscernible] is kind of where we are buying bonds today.

Okay, great. Thanks, guys.

Okay. Thank you, Dave.

Thank you. Our next question comes from Ken Usdin of Jefferies. Your line is open.

Thanks, good afternoon. I was wondering just on the expense side, the increase for this year that was kind of expected, you talked about the technology plan continuing to move forward. I’m just wondering if you could update us on the progress of the technology spending, specifically when do you expect that to peak and will that depending on your answer to peak, provide any tailwinds to future expense growth as we get out of '17? When does that start to come back to us in terms of that net efficiency improvement?

Sure, Ken. This is Scott McLean. So our core transformation project and all the related projects that was laid -- that laid the groundwork for that fundamental technology project, we’re well underway with all of that. We have basically disclose that the expense increase -- that's in our run rate right now, it was about $25 million in 2016. It will be in the low 30s this year. So there is only about a $6 million headwind, if you will, $6 million, $7 million, $8 million, in 2017. And this is a multiyear project. It's going to be going on for the next three, four, five years when you think about all elements of what we are doing. And as for how it will what the expenses will be in '18 and '19? They could be slightly higher than that 2017 level. But we really have not made a forecast or speculated about a forecast publicly in those years.

And as a follow up, you talked about what you have had as a partial offset to the spending. Is there anything else that you guys would contemplate on top of what you’ve already done to help self fund that tech infrastructure expenditure, because I think at some point there is an expectation that that gets to be a net positive, and your point is that it might be a little further out, so ….

Absolutely.

So what else is going underneath the surface as far as that’s concerned?

Right, Ken. So the incremental expense impact that I described is sort of the gross expense impact, if you will. So there are cost savings that we are identifying all along the path, some of which has to do with the technology itself and the expense savings that will allow us to achieve and I would say 2018, '19, '20. But most of it really relates to the fact just a continual process evolution we have had towards adopting common practices across our Company. We believe that in the narrowest sense that allowed us to save about $11 million in 2016. We believe that number will go up by $6 million, $7 million this year. It will be $17 million, $18 million in cost savings from just adopting common practices. And by the time we get to 2018, 2019, we believe that savings run rate will be in the $30 million to $40 million range. So the run rate I was talking about was sort of gross expense impact on the P&L, all of which will be offset or large part will be offset over time by the savings that we’re creating, so which is directly related to the technology other of which just had to do with the adoption of common practices.

Okay, got it. Thank you for the color, Scott.

Thank you. Our next question comes from Brad Milsaps of Sandler O'Neill. Your question please.

Hey, good evening.

Hi, Brad.

Hi, Brad.

Hi, Brad.

Hey, Scott, just wanted to follow-up maybe Texas for a moment. In the appendix you talk about the Houston CRE book polling in really well, it looks like it's as good or better in some cases in the rest of the CRE book, but just kind of curious if you could add any more color to that, there was a public REIT in Texas last week out with some pretty tough comments around at [indiscernible] rents at their Analyst Day, being down 35% or something kind of from the peak, but just curious any other color you can provide there. It looks like you guys are holding in quite well, but anything else you could add that would be much appreciated.

Sure, Brad. Happy to do that. You can see the relative size of our CRE exposure in Texas which is on Slide 24. And as you will note, about 60% of it is in the Houston area, San Antonio, Austin, the Dallas Fort Worth Metroplex, other areas where we have exposure, those economies are doing just fine. We don’t want a broad brush, but they really are doing just fine. The real issue is in Houston and it's important to note in the Houston portfolio that there is virtually no exposure to land, number one. Secondly, that the term exposure versus construction, it's about 70% term, 30% construction. And when you think about it, our office exposure which is headline news almost weekly across the country people want to write articles about the Houston office market, we have very limited exposure there, most of which is well into lease up. Generally speaking, projects less than a dozen by the way that are in the kind of 50% to 60% debt to cap. The multifamily area is clearly where the greatest weaknesses is. Industrial retail are doing just fine. Hospitality is showing some weakness, but really multifamily and our multifamily exposure is -- interestingly most of our multifamily projects that are in lease up are achieving within 5% to 10% of what our bank rate assumptions were. So, all in all, and what we are seeing from a deterioration standpoint, in the fourth quarter we saw a little bit of deterioration in the CRE portfolio, but not material. And we’ve had virtually minimal nonperforming assets and no charge-offs at this point. So the underwriting has held up really quite well.

Great. Thank you, guys.

Thank you. Our next question comes from Ken Zerbe of Morgan Stanley. Your question please.

Great, thanks. I guess going back to Paul's comments, you were talking about self funding the securities portfolio growth. Obviously this quarter had really strong total deposit growth, but how much of that is actually like a planned activity by management? Like we think about the securities growth, it's not dependent on cash, but are you changing how you gather deposits or the rate that you’re paying on deposits in order to build the securities portfolio faster than you may have otherwise?

Yes, this is Paul. Thanks for your question, Ken. I view deposits as critically important component to the value of the franchise. And so, regardless of what we’re doing with securities, we're going to be designing products and pricing them competitively and trying to bring in as many client driven stable deposits as we can. I mean, there is a lot of value there both in terms of profitability, but also liquidity. So I would not say that there is a direct linkage. Obviously to the extent you have a lot of deposits and exceeds your ability to grow loans, which has been pretty rare, in ancient history, but not so rare recently, that can help to fund securities growth. But short answer to your question is they’re not necessarily linked. The other thing I'd say, which I think we said in our prepared remarks is that a lot of the deposits that we saw in the fourth quarter were seasonal and so we’d expect those to migrate away in the first quarter. I hope that answers your question.

We haven't fundamentally changed our pricing or -- I mean you see the pricing is actually very -- totally stable between the two periods. It was actually down just a little bit on the savings and money market category. So anyway, they’re really not connected that way.

Got it. Okay. That helps. And then just a quick question, in terms of the provision, the guidance that '17 is essentially in line with 2016 provision expense, at what point is the reserve release, and then presumably a lot of it relates to the oil and gas portfolio, but at what point does the expected reserve release in the oil and gas portfolio slow to the point where you start to see an acceleration again, like how quickly does that run off?

Ken, this is Scott. The reserve even though the percentage went up just a tick in the fourth quarter, the actual dollar amount in the reserve went down a bit. And so we saw some relief there. And I think we’re being cautious about our outlook for the year. Clearly everything we're seeing is in the fourth quarter was pretty favorable happy to talk about that, but I believe that on the side for right now. And so, I think our basic assumption is if we continue to see the kind of improvement we saw in the fourth quarter, then you can certainly make a case that you wouldn't be reserving for charge-offs as they occur, and you can see that that reserve is about $200 million. So there is quite a bit that can come down there. You just have to pick what percentage do you think you would want to keep against the portfolio long-term and there is quite a distance between where we are in that percentage.

portfolio isn't what we think obviously:

Great. Okay, thank you.

Yup.

Latif, this is James. We just have a few minutes left, if we can go into the mode where we do one question per questioner and happy to take more questions offline from those same people if they’re interested in follow-ups. But we try to speed through the list here.

Yes, sir. Our next question comes from Geoffrey Elliott of Autonomous Research. Your question please.

Hello there. Thank you for taking the question. The weakness in C&I outside of oil and gas, you mentioned that it would be a bit disappointing in the quarter and that feels like it goes broader than Zions to other banks and industry data. What do you think is happening there? We hear lots of banks talk about their customers being more optimistic after the election, but so far it doesn’t seem to have manifested itself in loan growth. So what do you think is behind that?

I mean, they just finished counting the vote. I guess, it takes a little bit …

But it feels like it's going the opposite way. It kind of feels almost like it slowdown if you look at some of the data.

I guess, what I’m saying is that, you’re not going to see the effects of anybody's optimism reflected I think that quickly. I’m hoping you will see that play out during 2017. You know beyond that, we saw just -- I don’t know, somewhat was just kind of idiosyncratic we saw some larger pay downs, we didn’t see lot of larger deal originations late in the year as sometimes we would typically see and so I don’t know, Michael do you have any of this? Michael Morris, our Chief Credit Officer is here.

No, I will just add to what you’ve said that in the fourth quarter the election wasn’t determined, so that’s when deal flow would have picked up. We had the kind of loan growth we expected in C&I, so now that the election is over, I think we’re looking at the first quarter to see what that translates to potentially in the second quarter.

If I could add one more thing, I will point to slide 29, where we kind of -- its in the appendix, it’s a slide that we’re providing on regular basis and it shows linked quarter growth kind of by our affiliate banks and by type. And you can see that obviously we’ve a continuing headwind related to oil and gas and natural real estate C&D [ph] loans. And so we -- that was certainly a contributor to the fourth quarter.

Thank you.

Thank you. Our next question comes from Steven Alexopoulos of JPMorgan. Your question please.

Hi, everybody.

Hi.

Just a follow-up on the comments around C&I. One thing that stood out to me was your expectation for only moderate growth in C&I in 2017. I’m surprised, you’re not expecting a bit of an increase. I understand the drags you are talking about in this quarter and this year, but when you think about pipelines building, are you just been conservative or is there something going on that you’re not expecting better commercial loan growth this year? Thanks.

This is -- Steve, this is James here. One of the things that that we’ve made some adjustments to is on the multifamily side which you’re not asking about, but we also have made some modifications on the leverage lending side as well which is maybe one of the considerations.

I would just add to that too, we -- again if you sort of bench back to June 1 of 2015, we called for mid single-digit growth in loans and we haven't really changed our opinion about that. Over the last 18 months we've had some consecutive quarters of softness, we’re experiencing that now. In C&I I’m talking about specifically and -- but year-over-year we have solid progress there, that bubble chart that we show in here, shows that we’re growing year-over-year in the areas we want to, but we’re going to have some soft quarters in there and we think we’re in that kind of phase right now, but by the middle to the end of this year we think we’re going to put up loan growth numbers consistent with what we did for last year.

I just --- I would just add, this is really important topic I think, something we talk a lot about. Number one, it's just -- its hard to forecast. Now let me start with that. We haven't -- if we were really good at forecasting interest rates, we’ve not been very good at forecasting loan growth. And it's -- so I think there's a tendency to be cautious given the fact we’ve had a couple of quarters of slow growth. On the other hand, there are some things we’re doing, I mean, we’re just completing a reengineering of the way we approve and fund business banking loans. So these are credits, kind of small business credits or particularly in the $500,000 up to about $3 million range, that is going to make it much faster, I think a much better experience for customers and for our own people. And I expect that’s going to be in place by late second quarter. I actually think that's going to help a lot, we’re adding more mortgage loan originators. There are things that we’re doing that could speed this a little bit, but I think we’re made cautious by the fact we had a few months of slow growth here. And hopefully, just to the prior question, attitudes about the economy etcetera, will play a positive role too in stepping up originations.

I just want to emphasize again what I’ve said earlier and Harris said earlier too, our whole plan is not built around 10% loan growth. Its built around mid single-digit loan growth and the other elements that you know that we’ve talked about, so we’re not happy with the level of loan growth in the fourth quarter, but nor we fearful about being able to put up the year this year similar to the 2016 full-year results.

Fair enough. Thanks for all the color, guys.

Yup.

Thank you. Our next question comes from Bob Ramsey of FBR. Your question please.

Hey, good evening. Just want to be sure I heard you correctly, that the expected diluted share count is 210 million in the first quarter of '17? And if that’s right, I know you can't perfectly predict stock price, would it be your expectation to buybacks are sufficient to bring that down through the course of the year?

Obviously you guys can't even perfectly predict stock price.

This is Paul. What I said was that 210 million assumes the stock price is similar to what it is today and that also incorporates the expected buyback in the first quarter. So that is a net number.

For the first quarter not full-year, but for the first quarter?

For the first quarter, yes.

Okay.

And again we got an extra page in the appendix just so that you can choose your own path for a stock price and kind of assess from there, where you think diluted shares are going to be.

Looking at that page, I mean, how much of dilution was there in the fourth quarter and what was, I guess, the average price in the fourth quarter?

Bob, it's about 1 million shares worth of dilution due to the warrants and then I might also add that there are some stock exercise, some of the employees exercise stock option, so that was a driver of the -- some additional shares.

Okay.

I don’t have [technical difficulty]. Average share price in the quarter was -- about 37. It was about a $1 over the weighted average price -- weighted average exercise price of the warrants.

Okay. And have you all given any thought to, sort of as you think about CCAR next year, considering doing something about the warrants, as opposed to common share buybacks, or addressing them in some way?

That’s really always part of our -- as we think about capital planning, we’re thinking about all the capital instruments outstanding, preferred stock, and warrants and common stock, so that’s really part of our thinking and then we just try to sort out where the best value for shareholders is as we think about returning capital.

Okay. Thank you.

Thank you. Our next question comes from Marty Mosby of Vining Sparks. Your line is open.

Thanks for giving me a little extra minute here, to be able to get my question in.

You’re welcome, Marty.

I was basically looking at the sentence where you said, future net additions to securities balance is not limited by cash. I’m trying to take that, and look at your liquid assets on the balance sheet, which didn't change over the last quarter, even though you added so much in the securities, because deposits ran up.

Yes.

And then now, what’s happening is those deposits are going away, aren't we going to end up with a little bit of a pinch there? And Paul, is that why you were kind of already foreshadowing that future rate sensitivity would be adjusted through swaps more than the securities portfolio?

Yes, I wouldn’t call it a pinch, I would call it kind of a movement toward a normal kind of balance sheet net funding position. And as I said, I was -- I’m anticipating that securities growth will continue through the first quarter, but we're going to ultimately get to a size of a securities portfolio that we’re comfortable with to manage on balance sheet liquidity. And then from there on we’re going to need to manage our interest rate sensitivity through other mechanisms such as interest rate swaps, that's really what I was trying to get at.

I got you. I just didn't know how much of that big run-up in deposits, which was a big number, it was almost funded the complete increase in securities, if that’s going to all go away, then that starts to force you to start borrowing short-term, or begin to do some other things on the balance sheet. So just looking at it, you would be fairly effectively managing the deposits at that point, and then from there on you would use swaps like we talked about?

Yes. Couple of things. One, you can look at deposits last year, fourth quarter to first quarter and you can see that what we saw on the fourth quarter and what we’re expecting in the first quarter is kind of seasonal and we have seen it previously. The other thing I would out which, I know, you know Marty is that we really have zero incremental kind of wholesale borrowing. We are like a 100% deposit funded as an organization. And as a result, are in extremely strong sort of net funding position. So as I said, moving into the kind of a net borrowed position over time, and it's going to be probably relatively small, is completely normal in the context of our balance sheet.

Got it. Thanks.

Thank you. Our next question comes from Kevin Barker of Piper Jaffray. Your question please.

I just had a quick question on the securities balances, they’ve obviously grown quite a bit this quarter and have grown to close to -- a little over 23% of interest earning assets. And you let on, that you may continue to increase that balance, which I'd assume would be from other funding. At what level do you expect or are you comfortable getting the securities as a percentage of interest earning assets?

We haven't provided that level specifically, but I think I would point to the remarks that I’ve made, which is we saw a decent amount of portfolio acquisition in the fourth quarter. Our expectation is that kind of continues into the first quarter and then that’s probably going to be as we think about size of the portfolio, there is probably not going to be a lot of incremental need to continue to increase that balance sheet liquidity after the first quarter.

Okay. Thank you.

Thank you. At this time, I’d like to turn the call back over to Mr. Abbott for any closing remarks. Sir?

Thank you everyone for your time today. We appreciate your attendance and your interest in Zions, and we look forward to speaking to you in the future at a conference or at the next quarter's earnings call. Thank you and have a great evening.

Thank you, sir. Ladies and gentlemen, that does conclude the program. You may disconnect your lines at this time. Have a wonderful day.