Zions Bancorporation, National Association (ZION) Q3 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to Zions Bancorporation Third Quarter 2017 Earnings Results Webcast. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to hand the conference over to Mr. James Abbott, Director of Investor Relations. Sir, you may begin.

Thank you very much, and good evening. We welcome you to this conference call to discuss our 2017 third quarter earnings. For our agenda today, Harris Simmons, Chairman and Chief Executive Officer, will provide a brief overview of key strategic and financial objectives; after which, Scott McLean, President and Chief Operating Officer, will provide an update on the effects of Hurricane Harvey; and finally, Paul Burdiss, our Chief Financial Officer, will provide additional detail regarding Zions' financial condition, wrapping up with our financial outlook for the next 4 quarters. Additional executives with us in the room today include Ed Schreiber, Chief Risk Officer; Michael Morris, Chief Credit Officer; and other Zions executives who will be available to address your questions during the question-and-answer section. I would like to remind you that during this call, we will be making forward-looking statements, although actual results may differ materially. And 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 on our website at zionsbancorporation.com. We will be referring to these slides during this call. The earnings release, the related slide presentation and this earnings call contain several references to non-GAAP measures, including preprovision 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 that 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 is provided within the published documents, and participants are encouraged to carefully review this reconciliation. We intend to limit the length of this call to 1 hour. [Operator Instructions]. I will now turn the time over to Harris.

Thanks very much, James, and welcome to all of you on the call today to discuss our third quarter results. On Slide 3 of the presentation, we have provided some highlights for the quarter. We're really quite pleased with the performance as we continue to improve profitability while absorbing the cost of Hurricane Harvey during the quarter. We are pleased with the loan growth, particularly in the context of the relatively soft industry-wide performance in loan growth that we've seen so far. And because the growth didn't rely upon commercial real estate but instead was a result of growth in C&I and consumer loans, primarily on the consumer front, 1 to 4 family conservatively underwritten jumbo mortgages. We remained disciplined with the pricing of deposits. And the combination of those 2 factors led to a healthy increase in sustainable net interest income. In regard to credit quality, we remain pleased with the continued strong improvement within the oil and gas space, including a 12% linked-quarter decline in classified oil and gas loans and only $6 million of net charge-offs in the quarter. Loans outside of the oil and gas loan portfolio experienced generally pristine conditions with only 2 basis points annualized of loan losses, which is consistent with what we've seen over the past couple of years. With regard to Hurricane Harvey, I note the recovery effort has been incredibly impressive. I'm really proud of all our employees and the hard work that they've been doing for the bank, particularly there in the Texas market, even as many of them have been working to recover on the personal front from damage that they sustained at homes and cars, et cetera. While the hurricane was certainly disruptive, we've reached out to many of our customers, and relatively few of them were materially impacted, a lot of minor damage but nothing that causes us really major concern. After reviewing a lot of information from both bottom-up and top-down perspective, we set aside $34 million in hurricane-related reserves on the $8 billion loan portfolio that has direct exposure there in Houston. I'll cover the rest of the key indicators listed on this page as we move through the presentation. On Slide 4, our adjusted preprovision net revenue reflects steady improvement, up 20% year-over-year. Some of the growth is due to the benefits of rising interest rates and securities purchases, which we do not expect to be a significant contributor to growth over the foreseeable future. But we do expect continued moderate loan growth and customer-related fee income growth, combined with continued expense discipline, which should contribute to further positive operating leverage, although at a moderating pace relative to the very strong pace that we've experienced since 2014. Turning to Slide 5. We posted an efficiency ratio of 62.3% in the third quarter, which was adversely affected by Hurricane Harvey-related expense. Nevertheless, the year-to-date efficiency ratio was 62.6%, which is consistent with our 2017 goal to achieve an efficiency ratio in the low 60s kind of percentage range. Slide 6 depicts 2 profitability metrics, return on assets and return on tangible common equity. Return on assets increased to 97 basis points in the third quarter of 2017 from 84 basis points a year ago. Return on tangible common equity increased to 9.8% from 7.9% a year ago. In both metrics, the linked-quarter comparison is best understood when considering the interest income recoveries experienced in the second quarter, which did not repeat as expected in the third quarter. We're encouraged by the continued improvement and remain focused on achieving competitive returns on our assets relative to peers. Moving to Slide 7. We experienced 3.8% year-over-year growth in loans held for investment despite continued attrition in our national real estate, term commercial real estate and oil and gas portfolios. In the third quarter this year, we experienced continued strength in 1 to 4 family commercial and industrial and municipal lending. We were not dependent upon commercial real estate growth in the quarter. And in fact, that portfolio declined slightly from the prior quarter. We're comfortable with our loan concentrations. The economy is generally strong. We've made some improvements to the origination process, all of which should contribute to continued moderate loan growth over the next few quarters. Loan growth outpaced deposit growth over the past year by a modest amount, just shy of $400 million, which we funded with incremental wholesale borrowings. Our discipline around deposit pricing has led to a very favorable deposit beta, or the increase in the cost of deposits relative to increase in the federal funds rate, but we'll continue to evaluate based upon market conditions and funding needs how we deal with further rate rises and the need to balance our desire to continue building a strong deposit base with deposit pricing pressures in the market. I'm going to turn the call over to Scott McLean to discuss the effects of Hurricane Harvey with you. But before I do, I want to take a moment and express my appreciation to our employees and customers and particularly those who've been dealing with difficulties and challenges down in the Houston market. Between Hurricane Irma, which followed Harvey and the fires in California, et cetera, it's easy to forget the enormity of this storm that hit Houston with 50 inches or more, in some places, of rainfall within a very short period, unprecedented in the reported history of the United States. We had our people there who responded magnificently, helping customers, helping each other and really helping the community. Before I turn the time over to Scott, I want to congratulate him before all of you. While all of this was going on, he was helping coordinate our own response with customers and employees. He was also busy raising $35 million for the United Way down in Houston. We had another of our people, Barb Vilutis, who's the chair of the Red Cross for the Houston area. We had some people providing real leadership at a time of great stress down in Houston, and I'm really proud of them. And so with that, Scott, thanks for all you do, and I'll turn the call over to you.

Thank you, Harris. I'm happy to report, too, that we've actually got that United Way relief fund up to $45 million. We were highly motivated to exceed J.J. Watts' $38 million, so we had to go into extra innings over time to exceed his total, but we did, so...

That's great.

If you turn to Slide 8. Within the Harvey-impacted area, we have, as noted there, approximately $8 billion of loan balances outstanding and just slightly more than $100 million of municipal securities balances outstanding. To quickly address the municipal securities, we're not expecting any material credit losses largely due to the fact that 90% of these municipal securities are general obligation issues. As it relates to the loan balances, they're broken out by type on the chart. You can see that the dotted vertical line depicts the 3 major loan groups within our portfolio, with the key takeaway being that it's a diversified portfolio, the vast majority of which is held within the Amegy affiliate. In combination with significant client outreach and interaction, we applied several allowance for credit loss techniques and models to inform our decision to book a qualitative allowance of $34 million. Additionally, we recognized about $6 million of Harvey-related noninterest expenses, about 2/3 of which were occupancy costs basically, damage to buildings that were less than our deductibles; and about 1/3 was one-time expenses associated with recovery from the storm. And of that amount, about $1 million was given to employees in the form of grants, generally up to $2,000, and temporary housing allowances. It's also important to note that we made over 300 loans to employees, totaling about $5 million. This assistance was in the form of 5-year non-interest-bearing loans and really solid credit quality, as you can imagine. If you turn to Slide 9. We worked very hard to contact our commercial customers, as Harris noted and as I noted, and ultimately downgraded less than $70 million of loans due to the effects of the hurricane. Although it's important to note that most of those that were downgraded remained within the past range of our grading scale. So far, there have been minimal covenant waiver modifications made to commercial loans as well. Pivoting to Amegy's consumer loans. We are highlighting there the average loan-to-value ratios and consumer credit FICO scores of the 1 to 4 family known loans within the impacted area. This is reflected of the credit profile in June rather than after the storm. And so it may change in some situations as a result of the storm. But it goes to support the notion that we have a strong portfolio. I recognize, too, that the averages are only somewhat helpful. But we've reviewed the so-called tail risk of that $2.2 billion of loans, and it's really a low-risk profile. Only 3% of the affected area consumer loans took our offer for 90-day no-penalty payment deferrals. And although we have authorized a long-term loan modification option, we have seen very little activity on this program. All of this, combined with our statistics that are available at Houston.org, results in a general sense of comfort with our $34 million qualitative allowance. Just a bit of brief color on the storm so that you have a sense of really what goes on. The storm started on -- the rain started on Friday night, August 25, ended on Wednesday, August 30. And before the rain even began, we had successfully relocated the important operations activities that we conduct for Texas, as well as for the rest of the company. On Monday, the 28th, our customers were able to conduct every aspect of business other than that which is required to be transacted in a branch. And really, as you know, with the digital world, that's fundamentally the vast majority of transactions clients need. And on Wednesday, the 30th, despite the fact that it was still raining and the flood waters were rising, we were able to begin opening our branches on that day. Clearly, we concentrated our efforts to ensure our employees and families were safe. We then turned that attention to the well-being of our customers and the community at large. And as Harris noted, there were many great stories of volunteerism and leadership as he commented. Houston, as everyone knows, is a very diverse and resilient economy. There's no question the economy is back on its feet and running, in some ways, stronger than it did before. With that, I'll turn it over to Paul.

Thank you, Scott, and good evening, everyone. I'll begin on Slide 10. For the third quarter of 2017, Zions reported net earnings applicable to common shareholders of $152 million or $0.72 per diluted share, which is up from $0.57 per share in the year-ago period. There are some items within the third quarter of 2017 that are operating but generally infrequent, and those include, extreme weather-related expense of $6 million, which Scott just discussed; impairments to other real estate assets of about $2 million, recognized in the other noninterest expense line item; securities gains of $5 million; and gains of about $1 million on branch sales, and those show up in other noninterest income. However, all of these items, when you net them out, amount to less than $0.01 a share. Let me make a few comments about revenue. Nearly 80% of our revenue comes from net interest income. Slide 11 depicts the recent trend in net interest income, which continued to demonstrate substantial growth in the third quarter relative to the prior year period. Net interest income increased $53 million or 11%. The linked-quarter decline of $6 million is explained by the $16 million of interest income recoveries from 4 loans in the prior quarter, which we highlighted last quarter, and have noted in the footnote on this page. The most significant factor in the year-over-year increase in net interest income is the $5.5 billion average balance increase of the investment securities portfolio. Slide 12 shows the growth in the period-end balance of securities. With a relatively flat yield curve, we utilized a small portion of the cash flow from the securities in the third quarter, securities cash flow from -- securities portfolio in the third quarter, to fund a portion of the loan growth. As I've indicated in the past, we continue to exercise caution with respect to duration extension risk. As the securities portfolio is expected to be relatively stable for the near term, the growth in net interest income will become more dependent upon loan growth than it has in the recent past. Slide 13 is a graphical representation of our loan growth by type relative to the year-ago period. The size of the circles represent the relative size of the portfolios, and they are in no particular order on the page. Total loan growth, including the effects of a declining oil and gas portfolio and the national real estate portfolio, was 3.8%. If the oil and gas portfolio had been stable during the past year, which we expect will be the case going forward, the growth rate would have been closer to 4.4%. Originations and incremental draws on existing lines of credit during the quarter was stronger than the year-ago period by more than $300 million. The key takeaway from this chart is the relatively balanced growth for most of the loan portfolios, as represented by the circles. C&I, owner occupied and home equity loans all increased in the mid-single-digit range, while we experienced solid growth in 1 to 4 family and municipal loans. These are included in the other category. We experienced general stability in construction and land development and declines in term commercial real estate, oil and gas and national real estate. Shown at the bottom right is our expectation for loan growth by product type. We are comfortable with our commercial real estate concentrations and plan to grow commercial real estate at rates generally consistent with our overall mid-single-digit loan growth rate. Slide 14 breaks down key rate and cost components of our net interest margin. The top line is loan yield, which decreased 11 basis points from the prior quarter to 4.27%, but about 15 basis points of loan yield in the second quarter was attributable to recoveries of interest income from 4 loans. And net of that effect, our loan yield increased 4 basis points. Turning to the cost of total deposits. The average cost of total deposits increased to 12 basis points from 10 basis points a year ago, during which time the federal funds rate has increased 75 basis points, resulting in a so-called deposit beta of about 3%. Over the past few months, we have been selectively increasing deposit pricing in certain markets and with certain clients. But in general, we are not experiencing significant pressure to deposit pricing. On Slide 15. As most of you know, we reduced the interest sensitivity of the company and expected that, by doing so, the company would experience a substantial improvement to our stress testing results and experience a boost to current profitability. Because we transitioned to limited duration securities from cash, the difference in the spread between cash and securities in the third quarter of 2017 implies more than $90 million of incremental annual revenue when compared to the size of the securities portfolio in the fourth quarter of 2014. On the bottom left, we show the model effect on net interest income in a rate environment that is 200 basis points immediately higher across the curve relative to the current level. We would expect this to generate a 6% increase in net interest income annually. Turning to Slide 16 and noninterest income. Total noninterest income was $139 million, down from $145 million a year ago. We had a moderate decline in gains from securities as well as a slight decline in customer-related fee income. Beginning with customer-related fees shown on this slide, we experienced a decline of 100 -- I'm sorry, a decline to $122 million from $126 million a year ago. Within the loan sales and servicing line item, we had an impairment this quarter related to a loan that was held for sale that was nearly $2 million. Treasury management fees, which are included in deposit service charges, were stable from the year-ago period. However, retail deposit service charges declined slightly, almost entirely due to nonsufficient funds and overdraft fees. While that's not a bad outcome overall, it does adversely impact overall fee income. As noted in the press release, noncustomer-related activity, such as securities gains and dividends from small business and investment company investments, contributed to the bottom line, although not as much as in the year-ago period. We've experienced strong performance in wealth management and other certain capital markets products, and we acknowledge that we are not tracking as well as we had planned on some of the fee income items. However, we are still targeting mid-single-digit annual growth for customer-related fee income over the next year. Noninterest expense, on Slide 17, increased to $413 million from $403 million in the year-ago period. If adjusted for items such as severance, provision for unfunded lending commitments and other similar items, noninterest expense increased to $414 million from $404 million in the year-ago period. More than half of that increase was related to Hurricane Harvey which, as Scott said, rounded to about $6 million. Debt expense is split between about 2/3 in occupancy and 1/3 in other noninterest expense. Salaries and employee benefits increased $11 million from the year-ago period, which is mostly explained by unusually low incentive compensation accruals in the year-ago period. However, some of the increase in that line is also due to the substantial improvement in profitability this year versus last year, improved overall loan growth. Recall that last year, we only experienced about $50 million of loan growth in the third quarter and at better sales, all of which results in a higher profit sharing and incentive compensation paid to employees. A year ago, we indicated that we expected to experience an increase in total adjusted noninterest expense of between 2% and 3% for 2017 when compared to 2016 actual results. Despite expense associated with a major hurricane and higher-than-expected FDIC revenue-sharing expense and legal accruals associated with the recent settlement with the Department of Justice, we should end the year 2017 in about that range. Slide 18 depicts the overall credit quality metrics of our loan portfolio. We are encouraged with the meaningful improvement in classified loans, nonperforming assets and net charge-offs. Much of the improvement came from the oil and gas portfolio, and we remain optimistic that we will continue to see further favorable changes to oil and gas-related credits and measures. Although not shown on this slide, we have materially and substantially improved the average weighted risk grade on both the commercial real estate and commercial loan portfolios during the last 5 years, and we remain disciplined in our consumer loan underwriting criteria. As such, we expect manageable credit cost, while much of the provision for credit losses will cover incremental loan growth. Slide 19 is a list of our key objectives for 2018 and 2019 and our commitment to shareholders. We are fully committed to continuing to achieving positive operating leverage. We have a couple of years behind us at this point in our effort to materially improve profitability and grow earnings. We remain committed to further improvement and simplification of our operational processes. We expect to operate with an efficiency ratio that is consistently below 60% for the full year of 2019. We expect to continue to invest significantly in technology improvements, which include the substantial overhaul to our core systems. Back in 2015, we indicated that we were going to be targeting a much more substantial return on capital than what we could see then, and we are tracking well toward those goals, although there is still room for improvement. Regarding returns of capital, we have increased that amount to a level above the peer median, and we view a moderate increase of balance sheet leverage as appropriate, particularly given the reduction of the risk profile of the company. We are asked frequently by investors as to what the appropriate level of capital would be, and we have responded that the stress testing results are the primary driver. You can see our company run midyear stress test results on our website, which were just published this afternoon. But to highlight to a single number, our post-stress common equity Tier 1 ratio is 9.9%, which is more than a full percentage point better than the result 3 years ago in our first iteration of the midyear exam and well above the 4.5% minimum regulatory threshold. A second consideration is where we rank within our peer group. For various reasons, we believe it is important to remain somewhat stronger than the peer median. We recognize that the peer median is likely to decline over time. And so while the peer-median analysis is a relative threshold for us, the stress test is an absolute threshold that we need to maintain. Finally, Slide 20 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 is to be interpreted as an annual rate of growth in the mid-single digits. We expect net interest income to increase moderately over the next 12 months. We assume no additional rate hikes in this outlook. Additional increases in short-term rates are expected to improve net interest income. We posted a net provision for both funded loans and unfunded commitments of $1 million in the third quarter. Credit has continued to outperform our expectations. And thus, the cost has been less than expected, a trend which may continue. However, our base case scenario calls for a modest provision for credit losses over the next several quarters that is somewhat larger than the most recent quarter. 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 second quarter.

In the first.

In the first quarter, adjusted noninterest expenses. We expect to experience general stability in adjusted noninterest expense over the next 4 quarters. Bear in mind that the third quarter contains $6 million of hurricane-related costs, and we are not stripping that out when providing our outlook. Excluding adjustments for the 2017 accounting guidance for stock-based compensation, we expect our effective tax rate to be in the 34% to 35% range for the next 4 quarters, barring any meaningful changes in the tax code. We expect cumulative preferred dividends to be approximately $34 million over the next 4 quarters, and diluted shares may fluctuate due to both share repurchases and the dilutive effect from the outstanding warrants. The dilutive effect of the warrants is predominantly dependent upon the future price of the stock, which we describe in detail in the January earnings report. Please see the appendix for further sensitivities on the warrant effect. This concludes our prepared remarks. Brian, would you please open the line for questions? Thank you.

[Operator Instructions]. And our first question will come from the line of David Long with Raymond James.

Looking at the -- you guys held your deposit beta pretty low, and I give you guys kudos for that. Within there, you mentioned some selective increasing in deposit rates. I wonder if you could give a little bit more color there and maybe talk about deposit betas on retail deposits versus business deposits.

I'll start, this is Paul. The betas are somewhat geographically-dependent. As you know, the majority of our deposits are commercial, not retail. And so where we're seeing pressure is on the, I would say, the larger end of those commercial deposits. As you know, our deposit portfolio, particularly our commercial portfolio, is extremely granular and is comprised primarily of operational deposits. And those deposits, which represent the bulk in the value of our deposit base, have proven to be resilient and stable.

Got it, okay. And second question, in regards to managing the balance sheet, and you talked about the CCAR process with your regulators. As we're looking out to the CCAR process in 2018, is there any changes in how you're going to manage that balance sheet over the next couple of quarters?

Well, it sounded like there were 2 questions there. As it relates to the next several quarters, that capital management which I think is what you're asking about, is defined by the capital plan that was not objected to as part of that Horizontal Capital Review or CCAR process. Looking out beyond that, I would say that the activity that relates to managing the capital position of the balance sheet, will be dependent upon the underlying stress as measured in the portfolio by our models and the macroeconomic scenario that is defined in that stress testing process.

Okay, got it. Yes, I was looking out to the next process in 2018 and any adjustments you may be making on the asset side of the balance sheet here before we get to that process again.

I think, we have -- over the course of the last several years, through our concentration management process, through our investment portfolio management activity, I think that we have managed our balance sheet to a good place as it relates to stress testing. And I think you've seen that in steadily improving stress testing results over the course of the last couple of years. So as I look out over the next couple of quarters and balance sheet adjustments that may be required, I'm not seeing any.

And our next question will come from the line Ken Zerbe with Morgan Stanley.

Harris, you mentioned this but certainly opening it up for everyone, you mentioned that you're being very disciplined with your core deposit pricing. But if I read your release correctly, your core deposits are actually going down. Your short-term wholesale borrowing is going up. Can you just help us understand why is shrinking your core and increasing wholesale the right decision to make?

Well, what we're trying to watch is -- and I likened it to -- I don't know if this is a good analogy or not but a pot of water starting to boil. I mean, you see the first few little bubbles, it gets hotter, then it really starts to get into a boil. And I think we're sort of at that stage where we've had some increases over the last year that are certainly creating an environment where, particularly larger depositors, are finding it worthwhile -- they're looking around at alternatives. We are sweeping a lot of -- the very largest depositors, we're sweeping some of that over into money market mutual funds. We think we can get that back, but there's a price to do that. And so listen, I mean, at some point, the pace is going to pick up in terms of raising deposit prices across the industry. The question is just kind of whether you're at the front of that train or the back of the train. I think we're going tend to be toward the back of the train. So part of the cost of keeping rates low is you start to lose some of those more rate-sensitive deposits from -- particularly from larger depositors. And that's something we're talking about all the time, and I suspect every other bank is, too. There's probably about as much art as science to the thing because it's what can you change on the margin without repricing the entire deposit base, which is -- but ultimately, that's -- with further rate hikes, you'll start to see more of that. So in the early innings, you're going to see much less deposit beta than you are if rates continue to rise. And that's about the best I can explain it. I -- some of it, talk about the core deposits, I think, Paul was right, if you get under the hood and look at what's the stickiest, they are the smaller accounts. As they get larger, you're having a little more challenge holding on to some of those on the margin. And so that's just kind of -- a little description of kind of artistically how we think about it.

Okay. No, that helps. And then just the other question, in terms of the hurricane losses, are we done with sort of the noncredit-related hurricane costs? And even on the credit side, like how soon will you know what the actual losses are? I mean, how long does that process take?

I think just -- let me just take -- on the noncredit side, I think the only thing that will be a little -- I mean, it's a very modest continuing drag, we mentioned, that we made. We've made about $5 million noninterest-bearing loans to employees. And so you'll have -- that will effectively be a nonearning asset as those amortize off, but that's pretty modest. On the other side...

Ken, this is Scott. I don't -- in the grants we were making and housing allowances, I think that has pretty much subsided. And so on the credit side, we'll be able to assess that $34 million reserve really, I think, over the next 3 quarters. We'll -- we'll have pretty good visibility on it at the end of the fourth quarter and then -- but I expect that story will be over by the second quarter of next year, one way or the other.

Our next question will come from the line of Dave Rochester with Deutsche Bank.

Just a question on the expense guidance real quick. It sounds like you're talking about potentially this level bouncing around a little bit here. I know you said stable, but in order to hit that 2% to 3% adjusted expense growth this year. It seems like you need to step down a little bit in 4Q. And it sounds like that $6 million in Harvey-related expense is largely gone in 4Q. Is that generally what you're envisioning here when you're talking about the trend going forward?

Dave, it's Paul, I'd say that's generally true. The outlook -- as you know, the 4-quarter outlook in the prepared remarks, we combine that with a view of 2017 calendar, which we said was going to be within that 2% to 3%. So I think you've done the math appropriately there. And then, with respect to the last question and kind of going back to Ken's last question, that's right, the Harvey things, we believe, that we are fully accrued for any incremental expense associated with Hurricane Harvey, and that occurred in the third quarter.

And can you just talk about the offsets on the expense side because it seems like you're guiding to an expense growth rate that's a little bit less than what you had guided to for 2017, the 2% to 3%? Can you just talk about where you're seeing those saves? I know you kind of headlined that a little bit last quarter but maybe a little bit more detail would be great.

I don't -- correct me if I'm wrong here, but I don't think that we're guiding to a lower number. I think we've been pretty consistent that we would -- expenses would be moderately increasing. If you go back to June 2015, we've said expenses would be moderately increasing. In 2017, we referred to refine that to say 2%, 3% this year. And so we're sticking by that guidance.

Yes. I meant for over -- I guess, in terms of 2018, it sounded like you were guiding to less expense growth in 2018 than you were in 2017, that's what I meant.

I think we have used -- we have not defined in percentage terms what to expect in 2018 yet, but I'd say that we're using similar language for 2018 as we used in 2017. We'll give more color next quarter on that, Ken -- or Dave.

So just one more quick one. You've mentioned the economy in Houston is running, in some ways, stronger than it was before. I was just wondering if you're expecting any potential uptick, particularly on the deposit growth side as a result of the rebuild efforts, and how big could that impact be.

Dave, this is Scott. If you look at the loan growth in Texas over the last year and over the last quarter, it's been really a solid contributor to the company. Clearly, it's not energy-related, it's not oilfield services-related, it's just solid C&I and consumer growth. They've been doing a terrific job in that regard. It's having a nice impact on the overall company. And I think we would just say that, that ought to continue. I think their pipelines are looking pretty good. And you'll see working capital revolvers funding probably more than they have as activities picks up and certainly some reconstruction opportunities. We don't think of it as some windfall growth opportunity, but I think it will be a solid source of continued growth out of the Texas market.

And our next question will come from the line of Steve Moss with FBR.

Following up on the C&I loans, I was just wondering if you can give a little more color as to what were the drivers this quarter.

It's interesting because we've got a really diversified C&I portfolio, and largely, average loan size is really small. So there's all sorts of things that go into that. I believe we have a slide in the appendix, Slide 29, that provides a little more color as to kind of geographically where the loans are coming from. But because of the nature of the portfolio, it would be really hard for me to ascribe any 1 or 2 kind of trends or industries that are driving that. I would characterize it as pretty broad.

Well, I think it sort of describes our company, quite frankly. If you look at that on Slide 29, particularly third quarter '17 versus second quarter '17, it's just good, solid across-the-board growth. And in some of our smaller markets, you will have some large payoffs that skew growth in any particular quarter. But you see the same trend on a year-to-date -- on a full year-over-year basis, too, so -- but you really see it here in the third quarter, it's just nice, solid growth across the company.

Okay. And then my second question, wondering where are new money loans yields today versus your booked deals? And what your thoughts are on the margin going forward.

Steve, this is James. The new money yields are about consistent. Some of them are coming in at levels that are somewhat dilutive to the overall portfolio. And those would be on the higher credit quality characteristics of the loans that we're accepting today as opposed to some of the old loans that are rolling off. So there's a little bit of headwind, and maybe 1-or-so basis points of loan yield dilution per quarter is explained by that, if that helps. So high 3s.

And our next question will come from the line of John Pancari with Evercore.

Back to the expenses, I've got your guidance that you've provided here for 2018 and looking at the efficiency ratio. I know you're low 60s for full year '17. Below 60, I know, Paul, you mentioned consistently through '19. So about where do you think the breakpoint is, where it breaks 60%? Is that -- is it fair to assume that it happens at some point midyear? Just trying to get -- of '18? Just trying to get an idea of the trajectory there, when we can -- how we can expect that will play out.

John, thanks for your question. We chose those words deliberately. The -- as you correctly point out, we expect to be in the low 60s this year. And by the time we get into 2019, we're expecting to operate at below 60. And obviously, implied by that, there will be a transition point. But we have -- we're not providing any more specific guidance yet as it relates to efficiency ratio in 2018.

Okay, all right. And then separately, just around the -- back to the loan growth topic, I know the -- in terms of the outlook around demand, have you given us any color yet around the pipeline and line utilization? I know you said it's very granular, the trends you're seeing. But just want to get an idea, if you are seeing a broader pickup in demand, is this optimism that some of the borrowers had been commenting on post the elections is it starting to play out? What are you seeing there? Is there a general uptick?

I think like most other banks have reported, the postelection optimism hasn't really resulted in a groundswell of loan demand, but -- just simply from that. But generally speaking, across all of our affiliates, their pipelines are in pretty good shape, and we think our model of trying to get to mid-single-digit growth is very achievable. We'll also see, again, 1 to 4 family and CRE growing -- 1 to 4 family growing nicely, and CRE will grow modestly. But it should be good balance mix. And again, all of our affiliates are reporting good pipelines.

Yes, John, this is James, I'll just add briefly to Scott's comment that we're seeing positive results from the streamlining of our small business banking initiatives, and that's resulting in some much stronger pull-through rates. So the origination volume is translating into actual balance growth now for some of those small loans at a much faster pace than it was before. So that's another area where, when you peel back the onion several layers, you get down into that size, you can definitely see it starting to emerge. And hopefully, the trend will continue.

I would just add, if you just look at Slide 29, you'll see that the term commercial real estate combined with national real estate, which is a combination of both term CRE plus owner occupied CRE, the combination of them, they're down $545 million year-over-year. The National Real Estate portfolio probably continues to run off a little bit. I mean, the pace of attrition continues to slow somewhat. But that's really a secondary market, and a lot of community banks, just they're all anxious to hold on to good earning assets. And so the supply of product there is not as great as it used to be. So that will continue to run down a little bit. The term commercial real estate, our general objective has been to have that growing at a pace that is less than the growth we're seeing in the portfolio overall, just over time, to rebalance the portfolio somewhat away from CRE. And it's actually been running down this last 12 months. I don't expect that, that trend of absolute runoff continues the same way over the next 12 months. So I think that will be less of a headwind. That should help. But it's still a tough market out there. I mean, we've seen better loan growth than most others, but it's week to week. It's like every Monday morning, I look at last week's production and the net change, and it's a weekly cliffhanger as to whether...

It's the first e-mail we all open on Monday mornings. In fact, it's now coming on Friday nights occasionally, but they know we want to see it. The only other thing I'd add is that we've set out on -- when we've been out on the road, I maybe even said it last quarter, that energy -- the energy portfolio has been declining about $400 million to $500 million per year the last couple of years. And for the next 12 months, we anticipate that portfolio to be flat to potentially up. So that drag should be removed and may even be a modest support -- growth supporter.

And our next question will come from the line of Kevin Barker with Piper Jaffray.

In regards to the asset sensitivity, you put out quite a bit of disclosure. So it's been very granular, we appreciate that. But looking back at the NIM expansion that we've seen in the last year, obviously, there were some headwinds from the changes in your balance sheet due to growth in the securities portfolio and the growth in debt. If you were to replay the past year, assuming no changes in your securities balances or your debt balances, would your NIM be significantly above where it is right now, given deposit beta has been very, very low compared to your interest rate sensitivity disclosures?

I want to be clear I understand the question. Are you asking us to sort of go back and reset what the net interest margin would have been had we not purchased the securities? Is that what you just said?

Yes.

The NIM would not be below, in fact, the NIM would be -- not be above. The NIM would, in fact, be below where it is today. Think about where we've been buying these bonds. We've been buying them at like 2%, 2.25%, and the fed funds rate has risen from 25 basis points to 125 basis points. So even in the best possible outcome, the yield that we're getting on the securities far exceeds what the yield on the cash would have been.

So if you were to replay that right now, and assuming your interest rate sensitivity on the balance sheet, would you expect -- continue to expect a significant increase in the NIM going forward, if we were to have another 75 basis points move in the fed?

Well, the trick in our disclosures, and James and I have been talking a lot about how we talk about this, we've tried to talk about it, and the view is that we disclose a interest rate sensitivity that's based upon a 200 basis point parallel rate shock, which is generally the industry standard. However, every bank, I think, is sensitive to different points of the curve. And the parallel rate shock is really important here because what we've actually observed has been more of a twist kind of a bare flattener, where the short end of the curve has risen while the longer end of the curve has remained flat. And that, in fact, creates a pretty different outcome as it relates to changes in net interest income or margin related to changes in rates. And so we, absolutely, and I certainly stand by our disclosures as it relates to the parallel rate shock. The point that I'd like to make is that, in fact, what we're observing has not been a parallel rate shock, which is why maybe you have not seen the full amount of that "interest sensitivity" flow through to net interest income in any given quarter.

And our next question will come from the line of Ken Usdin with Jefferies.

Paul, if I could follow up on that. So if the loans are becoming a bigger proportion of earning assets from here, can that mix improvement more than overcome the expected increase in funding cost going forward before we consider any additional rate hikes?

Yes, Ken, I, actually, think about it a little differently. I think bank interest sensitivity is generally driven by the liability side of the balance sheet as much or more than the asset side. So I would say, going forward, as it relates to loan growth, the way those loans are funded are going to be really important. And continued control and management of deposit beta and continued high-quality relationship deposit growth is really what is, I would expect, to drive net interest income, particularly in a changing rate environment.

So okay. Then, I guess, the second question is just then, if we were to get more rate hikes, what do you think the benefit would be of the next one, given a gradual increase in beta from here?

Well, as I said, it kind of depends, and this is -- you're going to hate my answer probably, but it kind of depends on what happens to the rest of the curve. If the short-term rates go up and long-term rates stay stable or go down, that's going to have a very different outcome than if you saw a 25 or a 50 basis point shift across the curve. Generally, our asset sensitivity is pretty linear. That is to say, if you saw a 25 basis point shift across the curve, you could take our 200 basis point disclosure, divide it by 8, and come up with a decent proxy for the annual effect. But as I said, the real trick is predicting what happens in probably the kind of 2 to 7 part of the curve.

So then give me one little liberty then. Do you expect core loan growth to be above or below your core relationship-based deposit growth?

Well, that's really hard to predict. And I am certainly hopeful that we are going to continue to grow deposits, high-quality core deposits, that is -- at a rate that is close to our loan growth. But I think that's increasingly difficult for all banks in this environment.

But we have done that traditionally.

And our next question will come from the line of Gary Tenner with D.A. Davidson.

I wanted to just go back to loan growth for a second and maybe specific to the oil and gas portfolio, just very little runoff this quarter, certainly, as opposed to what we saw a year ago. So can you talk about kind of where -- with where energy prices are today and going through the redetermination period now in the fall, kind of what your thoughts are around utilization -- or excuse me, around commitment levels kind of getting through the fourth quarter and the appetite and demand for loans in that business.

Sure. We have clearly had a remix of our book. Energy services is now down to about 20% of our total energy loans. It was closer to 40% when we started the downturn in the end of 2014. And so we are seeing new underwritings on the reserve base side and the midstream side. We really don't do downstream financing, never have, and we don't plan on changing that materially. So we're just seeing really good solid reserve base loans and midstream, and we'll probably see utilization going up because they're at -- at these prices, there is good activity going on. And so it wouldn't -- again, we think our energy outstandings will at least be flat, possibly go up from here, but it should be a nice growth portfolio for us over time because it's a business we've been in and we're going to stay in, and we know the best people in the industry, and we know how to underwrite it, and the underwriting characteristics are as good as they've ever been right now.

And our next question will come from the line of Marty Mosby with Vining Sparks.

I wanted to look at the share count and the warrants. And you gave a great disclosure in the appendix of the presentation. But to take your share count from last year, 205 million, up to this year of 209 million shares, and then if you look at the stock price going from below $35 up towards $46, looks like you would estimate about 8 million shares that came out of that. So if you adjust the 209 million for that 8 million to be down to 201 million, so you would've gone from 205 million to 201 million. Is that really the dynamic? Is that pretty close to the relationship of how all that works?

Well, yes, Marty, I think that's right. As you know, there are other things that impact fully diluted shares. We highlight this as a pretty big one because it clearly has been moving the needle lately and will probably continue to do so. But generally, that is correct.

And then on the interest rate section, swap-wise, did you start putting any new swaps on this quarter? Or are you still kind of waiting to see interest rates start to shake out for -- kind of affecting that next part of the plan?

Yes, this gets to the, I think, the conversation around the shape of the curve. It's really hard for us, the ALCO committee, to get excited about extending duration on a purely interest rate perspective, that is on interest rate swaps, when we see the curve only providing really fractions of a percentage point for going out a couple of years along the curve. So it's a really long answer to your question, which is no, we are not putting swaps on, we're just -- we don't see the value of extending the duration today at that point of the curve.

So you'll just look for the right time when that yield curve gets a little bit better. And it's gotten a lot better in the last, let's call it, 6 weeks.

That's all relative, Marty.

And our next question will come from the line of Chris Spahr with Wells Fargo.

I have a couple of questions on expenses. First question is when does the management compensation and discretionary bonus plan kick in relative to the efficiency ratio for this year? And what is the threshold for the comp plan to kind of pay out or not pay out?

Well, when you say when does it kick in, it's actually incorporated into incentive plans that were put in place back early in the year and as well as, actually, plans that have been put in place the prior couple of years. So -- and those are sort of defined longer-term plans can also impact kind of the total amount of the pool available for more discretionary kinds of annual bonuses. So it's something everybody's kind of thinking about and focused on and something that we take into account as we're accruing toward to what we think the payouts out of these things are going to be. And the second part of the question was?

Just what exactly is the efficiency threshold that you guys target? I think you mentioned the low 60s, but I'm just kind of curious on the...

There is not a -- we haven't, at least publicly, defined a specific target for that for this year other than low 60s. I mean, you have to put this in the context of where we started a couple of years ago. There's been a lot of progress. But it is not a -- it's a factor that is taken into consideration in these plans but not with a specific on-off switch around a particular number.

And so this year is directionally consistent with what we did in '16 and the second half of '15, but -- it's directionally consistent but slightly different in the sense that we had very specific dollar amount targets and ratio targets in '16 and the second half of '15, and they were very much constraining variables on incentive comp. And we think about that this way this year, except we've described it as low 60s, and it is quite different.

Yes, there's a little more flexibility around it this year than was the case say last year.

And the quarter-over-quarter increase in salaries, that was all related to healthcare?

There was -- as we highlighted in the -- I think in the press release and certainly the slides, there was a health care benefit component of that increase.

Okay. And then finally, last question, on the year-over-year expense number for 2018, slightly higher. I don't know if I've seen that language for expense guidance before. Is that like 0% to 1%?

We haven't defined sort of the -- through a Rosetta Stone what exactly that means yet, although I expect we will. If you go back to June of 2015, what we said was that expenses would be modestly higher in '17 than '16. And we ultimately defined that as 2% to 3%. And so I would expect maybe a little more definition around that. As you can imagine, we're getting through our budgeting process and planning process right now. So as we get into the fourth quarter earnings call in January, my expectation is we'll provide a little bit more guidance around what that -- how to interpret that.

Thank you. Ladies and gentlemen, this concludes our question-and-answer session for today. So now it's my pleasure to hand the conference back over to Mr. James Abbott, Director of Investor Relations, for closing comments and remarks.

Thank you, everyone, for joining the call today. We really appreciate your attendance. And if you have further follow-up questions, I'll be around this evening for a couple more hours and then we'll be available throughout the quarter to respond to e-mails or phone calls. Thank you so much for your participation, and thank you for your interest in Zions.

Ladies and gentlemen, thank you for your participation on today's conference. This does conclude the program, and we can all disconnect. Everyone, have a wonderful day.