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Zions Bancorp. (NASDAQ:ZION)

Q3 2013 Earnings Call

October 21, 2013 5:30 pm ET

Executives

James R. Abbott - Senior Vice President of Investor Relations

Harris H. Simmons - Chairman, Chief Executive Officer, President, Member of Executive Committee and Chairman of Zions First National Bank

Doyle L. Arnold - Vice Chairman and Chief Financial Officer

W. David Hemingway - Chief Investment Officer, Executive Vice President of Capital Markets & Investments and Executive Vice President of Zions First National Bank

Michael Morris - Chief Credit Officer and Executive Vice President

Analysts

John G. Pancari - Evercore Partners Inc., Research Division

Paul J. Miller - FBR Capital Markets & Co., Research Division

Ken A. Zerbe - Morgan Stanley, Research Division

Joe Morford - RBC Capital Markets, LLC, Research Division

David Rochester - Deutsche Bank AG, Research Division

Keith Murray - ISI Group Inc., Research Division

Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division

Brad J. Milsaps - Sandler O'Neill + Partners, L.P., Research Division

Kenneth M. Usdin - Jefferies LLC, Research Division

Erika Najarian - BofA Merrill Lynch, Research Division

Gaston F. Ceron - Morningstar Inc., Research Division

Gary P. Tenner - D.A. Davidson & Co., Research Division

Operator

Welcome to the Zions Bancorporation Third Quarter Earnings Call. This call is being recorded. I will now turn the line over to James Abbott.

James R. Abbott

Good evening, and thanks, Jaimie. We welcome you to this conference call to discuss our third quarter 2013 earnings. Our primary participants today will be Harris Simmons, Chairman and Chief Executive Officer; and Doyle Arnold, Vice Chairman and Chief Financial Officer.

I would like to remind you that during this call, we will be making forward-looking statements, although actual results may differ materially. We encourage you to review the disclaimer in the press release dealing with forward-looking information, which applies equally to statements made in this call. A copy of the earnings release is available at zionsbancorporation.com. We intend to limit the length of this call to 1 hour, which will include time for you to ask questions. [Operator Instructions] With that, I will turn the time over to Harris.

Harris H. Simmons

Thanks very much, James, and welcome to all of you to the call today. Say, start by saying that in general, we are encouraged with the third quarter results. We're quite happy with the strength of our credit quality and the progress that we've made on reducing the cost of capital.

Looking back over the last year, I think it's especially noteworthy that we can report that the dollar amount of tangible common equity has increased nearly 15%, or nearly $550 million. That's a -- that's been a lot of progress. Talk about capital for just a moment, our common equity capital ratios, as I said, increased materially. They were boosted this quarter by preferred stock redemption, which effectively transferred $126 million from preferred equity to common equity. Doyle's going to elaborate more on this transaction later. Although it's something that we've been very transparent about in investor conferences and in our past SEC filings. Our Tier 1 common equity ratio, under Basel I increased to 10.4% from 10.0%. Although we still have some questions about how the Federal Reserve would be handling some risk weightings that will affect the Basel III ratio, we currently expect it to be above 10.0% as of September 30, 2013, totally phased in, assuming that we opt out, or in other words, exclude accumulated other comprehensive income from impacting the regulatory capital ratios. We expect the loan grow-- net loan growth didn't turn out to be as strong as we had anticipated. But we see a silver lining in the sequential quarter improvement in commitments, as well as an improvement in production. Growth was softer in the third quarter than it's been for 18 months, while residential mortgage and construction loans created some lift for us, it didn't get much lift from our commercial and industrial loan balances in the quarter.

These C&I loans have grown at a 10% compounded average interest rate for more than 2 years, but primarily because of elevated repayment activity in the third quarter, we experienced virtually no loan growth in this category. However, unfunded C&I commitments increased at a healthy rate, which is an encouraging signal. This will probably be a well-worn statement by banks this earnings season, but because of the elevated uncertainty coming from Washington of late, and we think there's a possibility that we'll continue to see a softer rate of growth than normal in the fourth quarter. An extension of the debt ceiling debate into January, doesn't really do much to help small businesses, who are kind of our bread-and-butter audience, to gain the necessary confidence they need to draw on their lines of credit and buy new equipment or build inventory.

Loan pricing remains competitive. Pricing declined a few basis points from the prior quarter, which is due in part to a shift in mix, with a little more residential mortgage than last quarter, and a somewhat greater amount of production of larger loans. We have mentioned on prior calls and the conferences for loan pricing pressure generally increases as the size of the loans increases. For Zions, the smaller loans account for about 2/3 of our total production and the like amount of our overall portfolio. Nevertheless, because we're still experiencing adjustable rate loans resetting at lower levels and real estate loans refinancing at elevated speeds, we don't expect -- rather we do expect further pressure on loan yields. We don't expect that pressure to let up quite yet.

Credit quality is very encouraging. Our gross charge-offs are significantly below many of our peers' net charge-off levels. This quarter, net charge-offs were only 9 basis points annualized of average loans. The release provided statistics on the continued improvement in classified loans and nonperforming assets. But I might add that nonperforming asset inflows declined about 15% compared to the second quarter, and that loss severity rates also improved. Both of those bode well for further improvement in credit quality ratios. This continued improvement resulted in a further release of the allowance for credit losses.

As we have stated regularly, Zions is significantly asset-sensitive. Not only do we expect earnings to increase when rates arise, we expect to be able to avoid the significant haircut to equity that many banks may experience and some have already started to experience. There's a heavy concentration to long duration assets with securities with negative convexity. Under an immediate rate shock scenario, where rates rise 2 percentage points in a parallel fashion, our current estimate of the market pie of equity, which is the present value of assets plus the present value of liabilities, rises nearly 6% under a deposit repricing scenario that has us repricing our deposits reasonably fast and it increases nearly 12% under what we'd call kind of a slow deposit repricing scenario, of the 17 peer banks we compare ourselves to, only 7 report such a figure. But of those that do, about 70% reported negative market value of equity in that kind of a scenario. So we're -- we continue to be cautious in the way we manage that.

So with that overview, I'll now ask Doyle Arnold to review the quarterly financial performance. Doyle?

Doyle L. Arnold

Thanks, Harris. Good afternoon or evening, everybody. As noted in the release, we posted net income applicable to common of $209.7 million or $1.12 per diluted common share for the third quarter. That compares to the prior quarter of $0.30 per share. There are 3 significant items that impacted the results and 2 of those items occurred in the third quarter and one occurred in the second quarter, but wasn't repeated. So let me highlight each of those for you. As mentioned, we called the Series C preferred stock in the quarter on September 15, which triggered after-tax income to common equity of $126 million, as Harris mentioned. Essentially, the par amount of the Series C preferred was $800 million at the time of the call, but the book amount was $926 million, with the difference being the value of the so-called beneficial conversion feature that arose out of, if you go all the way back to 2009, to the modification of the, some of the subordinated debt that we had at that time. The call then triggered the movement of the $126 million from preferred stock to retained earnings, and that occurred via an income statement line that you've not seen before, and probably will not see again from us. It's called preferred stock redemption, just below the preferred stock dividends on Page 10 of the -- which is the income statement in the earnings release. If you've got additional questions about how it was created, or why calling the Series C triggered this in the third quarter, we'll be happy to discuss that further later. But I think most of you were expecting a change in capital. Some of you might not be -- have been expecting, in fact, well, based on consensus estimates, probably few, if any of you were expecting it to go through the income statement in the way it did. But it's clearly isolated there for you.

The other third quarter earning that -- or third quarter item that impacted earnings this year arose from our ongoing review of our allowance for credit losses. In this case, specifically the reserve for unfunded lending commitments, which based on our experience, we refused. Line utilization rates as we have discussed from time to time on these calls or with you in person, have remained below historic averages for quite some time now. And essentially, we adjusted our credit conversion factors to use a lower expected line utilization rate in setting the reserve for unfunded commitments. This change in assumptions and models accounted for $18.4 million of the $19.9 million reduction in the RULC, and the rest was just the normal change in unfunded commitments outstanding and loan grading, et cetera.

And finally, the third item is that in -- remember in the last quarter, we had a $40 million pretax charge that was related to the successful tender offer for $258 million of our pretty expensive senior notes, as well as the redemption of the 8% Series B trust preferred issue. The expense was a result of the tender premiums and discount accretion on those instruments in the second quarter and wasn't -- and didn't repeat, obviously, in the third quarter.

So let's go through some of the revenue drivers now. We'll begin with a review of some of the key drivers on Page 15. Average loans held for investment increased $300 million compared to the prior quarter. In the period, loan balances increased $142 million, excluding FDIC-supported loans and loans held for sale.

The total loan production actually increased 4% sequentially as, because, as Harris mentioned, there were a higher level of repayments this quarter. We did not achieve the net loan growth that we had experienced in the prior quarter. We, along with several other banks, sent a cautionary signal at the Barclays conferences in September in this regard, and net growth was there, but it was slower this quarter. As an example, the C&I repayment rate was 13% higher than in the prior quarter, or about $350 million more of C&I loan runoff, not counting their originations. Anyway, $350 million, more runoff than in the trailing 4-quarter average.

Turning to Page 11, we have a couple of highlights from the loan table. Commercial industrial loans were relatively flat in the third quarter compared to the second. However, unlike recent quarters, we actually experienced attrition in C&I loans in Utah and Texas, while California, Arizona and Nevada experienced relatively healthy growth. So almost role reversals there between our -- the banks for a number of quarters have been the strongest and some of the others that have been more flattish.

Line utilization rates on revolving C&I loans declined further relative to the prior quarter, and we're at 32.2% compared to 33.2% at the end of the quarter. And again, for reference, we were kind of precrisis running in the 38% to 40% was a more normal utilization rate.

Construction development loans increased $49 million or about 2% sequentially, a slower rate than in the prior quarter. It was due entirely to higher repayment speeds in the third quarter. As we've discussed previously, new construction commitments have been fairly strong for the last several quarters during a period when pricing terms and covenants were very good. These loans are now in the funding stage after the equity has gone into the project. Total new unfunded commitments increased only 1% sequentially as we're hitting self-imposed concentration limits in some construction loan types in some markets. And in those markets, we are effectively constraining further growth.

As is evident from the runoff rates, some of our construction projects have completed, and are finding long term permanent fixed rate financing away from us, which is a segue into term CRE, which declined for the fifth quarter out of the past 6, in part due to the refinancing I just mentioned, and in part due to our national real estate book of business running down, which we've discussed in detail on previous calls. Excluding that national real estate, term CRE loans would've grown at a moderate rate.

Our production volume increased in term CRE, but it was concentrated in a small number of large syndicated deals. On those deals, the pricing was a bit thinner, but given the very low credit risk, we elected to participate, and those transactions resulted in a lower weighted average pricing on term CRE this quarter by about 33 bps. However, excluding the largest deals, the pricing on term CRE was actually quite stable across the other various sized buckets that we track and has been for the last 3 quarters.

Consumer lending improved materially, with balances rising by $163 million, which is primarily attributable to residential mortgage in the credit card businesses. On residential mortgage production, the weighted average coupon was 3.6%. It had a weighted average time to reset of 5.5 years on the production this quarter.

FDIC-supported loans continued their steady decline, which has been in a fairly tight range of $45 million to $60 million per quarter as we continue to work out of that portfolio. As it pertains to interest income and indemnification expense related to this loan book, we currently believe that the current expected cash flows will be nearly $80 million over the next 5 years, although most of that will be realized by the end of 2015, which compares to $21 million recognized in the third quarter.

The indemnification asset amortization expense, which is a subcomponent of other noninterest income, should amount to about $42 million and be exhausted by the end of 2014. So my general comment is that this portfolio continues to outperform the assumptions that we used when we priced it, but the accounting was, is and will remain complicated. And James will be happy to walk you through all of that if -- those of you who want to torture yourself with it. But it's important to realize that, that asset is still large enough and the accounting is such that it -- these entries each quarter materially impact both interest income, as well as noninterest expense, and they tend to offset each other partially when you get to net income at the bottom.

Okay, margin and net interest income, Page 15 of the release, you'll note that the NIM declined considerably compared with the prior quarter, about 22 basis points of decline. However, recall that in the prior quarter, we had indicated NIM benefited from a significant increase in income -- in interest income from FDIC-covered loans, and that we did expect this benefit to drop considerably in the third quarter, which it did, back to something more like the run rate of the prior couple of quarters, by the second quarter and a couple before that. Total interest income from FDIC-supported loans fell to $21 million from $35 million, which accounted for 11 basis points, or half of the NIM compression. The further buildup of cash, which is now 18% of earning assets, further impacted the NIM by about 3 basis points. The rest was due to the ongoing pressure from the loan book resetting as old loans run off and -- or roll off, and are replaced at lower rates and spreads.

Although we ceased providing a core net interest income number, we did commit to giving you the components, so that you could continue to calculate it. The additional accretion is found on the table at the bottom of Page 11, equaling $15 million and a discount amortization on sub debt was $12.8 million. That's a number I don't believe you can find as a single line item, but it's buried in interest expense. Adjusting for these factors, there was about a $1 million linked quarter decrease of net interest income, or not very much.

Turning to noninterest income, after adjusting for the noise and the securities gains/losses, this was a pretty straightforward quarter, with 2 notable items. The first being the decline in loan sales servicing, which was attributable to a drop in mortgage refinancing volume. I doubt that, that surprises any of you. Our refi volume declined 36% sequentially. But our purchase volume increased 8%. Second item was a $4 million gain on the sale of several branches from our California franchise, which is included in other noninterest income.

Turning to the noninterest expense, the salary and benefit line increased modestly. There are a number of moving parts, such as lower incentive comp, offset by base salary increases. But in general, it's trending in line with previous guidance in a modest expected growth rate. Also in July, we set expectations that professional and legal services expense will be elevated through at least the end of the year. And these are largely consulting expenses related to improving our stress test capabilities as we graduate into the CCAR class, and there's a lot of work to do that is being done there. On credit, I'm going to skip credit quality, other than to echo Harris' comment that things look very good and seem likely to continue to improve on most fronts, including NPAs and classified assets.

With regard to capital, we completed the call of the Series C in September as we discussed. This should end a, what has been a very significant noise source in the earnings reports for the past 4 years. Going back to June of 2009 when we modified the sub debt to include an option to convert into preferred stock. And more than $750 million of conversions actually took place in rather unpredictable and volatile amounts each quarter there for several years. And we finally, the last entry probably is the -- moving the beneficial conversion feature from preferred back into common, $126 million that we just did. Although the -- I know this has been noisy, and at times frustrating to many of you trying to model the company. The cost of this capital was considerably lower than if we had just issued common stock back in June of 2009 when the stock was trading at less than 50% of tangible book value, I will note that our regulatory capital ratios, common equity Tier 1 on a Basel I basis increased 40 basis points to 2.43%, and -- what did I say? Two? Sorry, I'll send the defibrillators out to anyone who got panicked by that, 10.43%. Other regulatory capital ratios came down a bit because of the call of the Tier 1 -- other Tier 1 preferred stock during the quarter.

The -- turning to -- wrapping up with a little bit of outlook, and then we'll take your questions, with regard to loan growth, this one's tough. It's frankly hard to predict. Our lenders report to us that we have not noted a major step down in customer optimism, given all the goings-on in Washington, although it's probably too early to tell. And as I think Harris mentioned, we've got another go around potentially in just a few months in January. A number of you used to ask whether we were kicking the can down the road in converting some of our C&I, our -- excuse me, our construction real estate loans into term and we assured you not. We can't hold a candle to the can kicking. It seems to be going on in Washington these days.

In addition, because of the strong appetites by nonbank entities, such as life insurance companies and pension funds, which we don't expect to abate, we're probably going to modestly lower our outlook on loan growth to slight to moderate, instead of just moderate over the 1 year time horizon. But I will tell you that loan growth through the first 3 weeks of the quarter has been pretty good, and the fourth quarter generally is a pretty strong one for us, particularly in the last few weeks of the year, which then reverts in early January.

The bottom line is, pipelines remain fairly strong, line utilization remains fairly weak. And it's just really hard to figure out. There's no compelling change in the direction either -- certainly not getting dramatically weaker. But there's no evidence that the sentiment in loan demand is growing stronger out there that we can see, either.

So net interest income, excluding any effect from this -- the expected decline in interest income from the FDIC-supported loans, we expect net interest income to decline modestly, primarily due to loans resetting at lower rates, as well as new production yields that are averaging near 3.8% on a weighted average basis compared with the current book yield of 4.4%. I might note, there's not that much price softening going on. There's price pressure, but a lot of that yield is mix, where we've got more residential mortgage production than has just now, historically been the case.

Noninterest income, we expect the less volatile components of noninterest income, such as service fees, to continue on a modest upward trend. Noninterest expense should be somewhere near $400 million in the fourth quarter. This factors in a more normal provision for the unfunded lending commitments, a more normal legal accrual and some increase in expenses from our core processing systems conversion project. We expect that provision expense will remain negative, given modest loan growth and a continued improvement in problem loans. And in light of what by almost any metric is an ALLL that is among the strongest in the industry. So the outlook is for continued modest reserve releases over the next few quarters.

Although we continually evaluate the reasonableness of various factors that drive the model, we don't expect a recurrence of anything like the magnitude of change in the reserve for unfunded lending commitments that we did this quarter, particularly until we see a more consistent drawing down of unfunded commitment lines.

Preferred stock dividends in the fourth quarter should drop to about $17 million or $18 million, and should total about $66 million in the year 2014 with just due to the timing of dividend payments, will vary a few million, up or down on a quarter-to-quarter basis. But the total for the year should be about $66 million.

Jaimie, with that, we will take questions, and will you please open up the lines?

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from John Pancari from Evercore Partners.

John G. Pancari - Evercore Partners Inc., Research Division

I just want to see -- if you can give us a little more color on the outlook for the loan yield more specifically, I mean, it looks like x the FDIC items, the core loan yield was down about 12 bps, I guess, linked quarter? Correct me if I'm wrong. And should we expect a similar decline of that magnitude based on your comments there, Doyle?

James R. Abbott

Hi, John, this is James. I -- the -- I'll tell you, most of the compression in the loan yield this quarter compared to last quarter, was due to really 2 factors. One is the residential, higher concentration of residential mortgage, which is coming in at 3.60%. And that's substantially below where we were at, the 4% the last couple of quarters in overall production. But then the other one is the large loan volume. We did 2 or 3 loans this quarter, there were some syndicated credits, and those had very solid backing and as a result, they had a little thinner spread than what we normally would participate in. But -- so it's hard to say that it's going to continue to drop at 12 basis points per quarter but...

Doyle L. Arnold

I would say it's -- that I hope and I think that, that 12 is probably a little more than we should expect on a quarter-to-quarter basis if we -- again, if we abstract away from a few large syndicated credits, and we -- if we see more a rebound in our bread-and-butter -- excuse me, C&I middle-market type of lending, the pricing on that is not as pressured in some other markets. And I think the -- probably that level of pressure is overstating the case.

John G. Pancari - Evercore Partners Inc., Research Division

Okay, that's helpful. And then my follow-up will be on the securities side. So the amount of increase and securities balances this quarter, just wanted to get a little more color there and then, how we should think about the securities yields. So I know they moved quite a bit in the quarter as well.

Harris H. Simmons

David Hemingway, our Chief Investment Officer is here, and he's clicking at the available for sale... David, that increased be about 149, or so?

W. David Hemingway

Yes, we did just buy some floating-rate agencies obviously, that had lower yield than the other available-for-sale securities that are in there. Obviously, we have a higher yield than the money market, yes that's at just -- had sat at 25 basis points. So I would think as we see some opportunities to increase the overall income, without taking a negative convexity risk or without taking credit risk, we'll probably continue to buy a few things. But I wouldn't expect anything dramatic.

Doyle L. Arnold

I would note that even with buying a bit of securities, our total cash and due from and money market actually continued to increase in the quarter, in part driven by -- if you look at the balance sheet, about a -- over a $700 million increase in noninterest-bearing demand accounts, which the money -- another sign of perhaps indecision, at least on the part of commercial customers, because that remains the primary place where those DDA balances are growing.

Operator

The next question comes from Paul Miller from FBR.

Paul J. Miller - FBR Capital Markets & Co., Research Division

And on the deposit side, you just mentioned that you're having a tough time putting the money to work on the loans, and most banks are, and you don't really want to extend your securities portfolio, why not try to drive some of those deposits out, that's probably being a drag on your NIM?

Harris H. Simmons

Well, we don't want to drive deposits out by driving customers out. And it's basically existing customers leading more cash with us, and we're going to assume we're providing -- let's just say about as little an incentive for them to do that as we can conjure up. So it remains a struggle to -- because, I mean the fundamental cycle here is that the Fed is pumping -- continuing to pump liquidity into the economy, and it piles up when people and companies that are cautious and undecided and uncertain about what to do with it. So here it sits. And we, in turn, park it, give it back to the Fed, I guess, so they can buy more bonds. And wash, rinse, repeat. But I don't have a good answer for you. It's something we just continue to struggle with, and we haven't found the magic key. I mean, it's having our customers, having that degree of confidence in us that they'd rather keep their cash here than in a money market mutual fund or -- at another bank, we like that part of it. But it's not a good problem.

Doyle L. Arnold

I mean, we've got about, I think about $2.6 billion that we've -- have helped customers move into money market suites. And so we're looking for opportunities where that makes sense for them and for us.

Paul J. Miller - FBR Capital Markets & Co., Research Division

And a follow-up question, is there any regions doing better than other regions? I know you have a pretty good diversified customer base, but I'm just wondering, is California doing better than Texas? Or where do you see -- and do you see any growth out there in some of the geographic areas?

Harris H. Simmons

Real estate demand, commercial real estate demand remains reasonably strong in a lot of areas. I think the big change this quarter was the softening in C&I demand in Texas in particular, which had been a driver of growth. Whether that is something that's likely to persist or not, we've not had the time really to delve into that. But -- and as we mentioned in the remarks, so in general loan growth was a little stronger in Arizona and Nevada and California than it had been. James, do you want to -- do you have any other color you want to add there?

Doyle L. Arnold

It looks -- actually, things look reasonably pretty -- with like I said, the exception of the -- Amegy this quarter had a $32 million decline in commercial and industrial loans. And historically, Amegy has seen $150 million to $300 million worth of growth in C&I in a quarter. So that was probably the one spot that was softer than it historically has been. Otherwise, certainly very encouraging to see Nevada and Arizona and Colorado strengthening, clearly strengthening.

Operator

The next question comes from Ken Zerbe from Morgan Stanley.

Ken A. Zerbe - Morgan Stanley, Research Division

I think you mentioned that growth was a little bit stronger and I think that commercial growth was a little bit stronger in the first couple of weeks of October. Is that due to a slowdown in prepayments or is it actually due to more of a rebound in the underlying demand for loans?

Doyle L. Arnold

I -- do you have an actual answer?

Harris H. Simmons

Well, I was just going to-- unless repayments, altogether, stopped at Amegy in a 1-week period of time, I would say that there's some additional line of credit growth people have drawn on their lines at Amegy. We've seen over $100 million worth of C&I growth just at Amegy in the first -- so far this month. So I don't think there's massive change in prepayment speeds. Doyle?

Doyle L. Arnold

No, I was going to say the same thing. It's probably just -- I mean, that -- we've seen, in total, I think it's something like $150 million of growth in 2, 3 weeks. $100 million of it is there at Amegy in C&I and it's got to reflect just draws on existing lines of credit, nothing else changes that much that fast really. And the question is, is that -- we haven't seen this -- we've mentioned, because we've talked to some of you about it, this is -- we've seen a strong first month of the quarter in the third quarter and in the second quarter, followed by real softness in the second month of the quarter, followed by some strengthening again in the third. Whether that is going to prove to be a persistent pattern or what this represents, there's no way for us to know at this point.

Ken A. Zerbe - Morgan Stanley, Research Division

All right, that helps. And then just a follow-up question on the resi growth in the quarter, obviously this isn't where, I guess -- I'm going to say it's not your area of expertise if I could say that. But how much growth would you be willing to put on in resi if we don't see any meaningful improvement in commercial over the next several quarters?

Doyle L. Arnold

Harris, do you want to comment on our residential mortgage initiatives and what we've been doing there or would you like me to?

Harris H. Simmons

No, I'd be happy to. I mean, we're doing a lot of kind of reengineering in the back office, on the residential mortgage operation. Our expectation is that eventually that's going to allow us to support higher levels of production. We think there's more we can do, given sort of our natural market share, if you will, in a lot of these markets. And while we've been pretty underweight in residential mortgage, I'd tell you that anything we put on the books is going to have reasonably modest duration to it. I think you all know kind of how we think about negative convexity risk that I've been talking about so much. But it's going to take -- I think it's going to take -- it's not going to show up immediately. And I think we've got a reasonably decent business there. It's one we think we can turn it into a really great business. But it's -- but that doesn't happen overnight. I do think that you're going to see a better environment for us in this business. There are a lot of private -- a lot of lenders that are just going to find it too complicated to be in the residential mortgage business. I think that you're going to have some very small community banks making under 500 loans and they'll have some exemptions under the QM rules. But there's a whole other tier of banks, over $ 2 billion and over 500 loans, who I think are going to have a tough time having the scale to be fairly effective in that line of business.

Doyle L. Arnold

I would -- I'd comment more broadly. I mean, even with this growth, I haven't actually calculated, but I'm pretty sure that our total consumer portfolio is probably still less than 20% or in the neighborhood of 20% of total loans. Strategically, that is -- we would like to grow consumer to a somewhat larger percentage of the total, and the 2 natural areas for us to do that are to focus on some 2 product lines that really had not been a focus previously. One is resi mortgages, both first and equity lines, the other is credit card, where we're starting off a much smaller base but plan to grow in both cases within our footprint, kind of serving our community regional bank customer base. And that's what you can expect as the offset to what clearly will be less concentration than, if you go back to the mid-2005, 2006 era in commercial real estate, particularly in land lending and early-stage development lending. So less CRE, more consumer and lots of C&I is what we'd like the portfolio to look like.

Operator

The next question comes from Joe Morford from RBC Capital Markets.

Joe Morford - RBC Capital Markets, LLC, Research Division

I would just circle back, more to clarify than anything else, on the slowdown in C&I this quarter, which sounds like principally Amegy but somewhat Utah too. So do you just not have much of an explanation for that yet or is there -- do you have a sense more what's kind of behind that trend, which is reversal from what sounds like several quarters now?

Doyle L. Arnold

We've got Michael Morris, our Chief Credit Officer here. He can talk a little bit about Utah, at least. Go ahead, Michael.

Michael Morris

Well I think you've picked up on Amegy. I think some of the attrition has come through the National Real Estate Group which does a lot of owner-occupied financing, which gets classified as commercial. So some of that rundown is intentional and...

Doyle L. Arnold

That's probably Utah and the National Real Estate, not at Amegy.

Michael Morris

So at Amegy, I don't -- I think the economy there remains very strong. I don't -- the frac-ing boom continues, et cetera. I don't have -- wish I could text Scott McLean if he happens to be listening in, but I can't because I don't have a sense that anything fundamental has changed in Texas and why we had this pause this quarter, I'm not quite sure.

Joe Morford - RBC Capital Markets, LLC, Research Division

Okay. And it sounds like it's already off to a good start this quarter, so that makes sense. And then just, I guess, a separate follow-up is can you quantify what term CRE pay downs were this quarter and how did that compare to the amount you saw last quarter?

Doyle L. Arnold

James is flipping through his chart book. I'm going to stall for time here while he finds it -- okay.

James R. Abbott

The repayment rate this quarter was about 32%, Joe, compared to about 27% last quarter. So the -- I'm not sure if that's what you were looking for, but the national real estate if you're tracking that, that was down about $75 million compared to the prior quarter. So if you normalize for that, we saw about a 20 -- a little over $20 million increase in terms of commercial real estate if you exclude the effect of National Real Estate.

Harris H. Simmons

I would make just one quick observation there, Joe, and that is if you look at the 5-year treasury, that we've -- today it's about 135 [ph]. Five years ago today, it was about 282 [ph]. But by the end of 2008, it was down to 155 [ph]. So, I mean, if things really changed pretty precipitously toward the end of 2008, beyond that may have made a very, very little sense. So I do think that will probably get -- going to get to a point where that's the kind of the risk-free rate and you've got the credit spreads on top of that. They've certainly [indiscernible] to it too. But I do think that the impetus for refinancing and the reset rates at which things are refinancing, because a lot of our resets on some of this longer-term paper -- longer-duration paper tends to be about 5 years, I think, within a couple of quarters, we're going to get to a point where a lot of that has bled through. But I -- I mean, that's just my opinion.

Operator

The next question comes from Dave Rochester from Deutsche Bank.

David Rochester - Deutsche Bank AG, Research Division

On the last call you guys talked about the haircut you need to take on your Tier 1 capital calculation under Basel III because of the CDO book. Can you just update us on whether you've gotten any closer to finalizing what that's going to be, ultimately? And then if you haven't had that Tier 1 capital ratio adjusted for this quarter for Basel III?

Doyle L. Arnold

There's still a little bit of uncertainty in the CET1 under Basel III but fully phased-in. I believe, as Harris mentioned, we now estimate that it would be north of 10%. The -- so it's pretty -- that's a pretty strong Basel III. It's going to be somewhere, we think, in the 10% to 10.5% range.

David Rochester - Deutsche Bank AG, Research Division

And the Tier 1 capital ratio?

Doyle L. Arnold

Now that one -- I was going to say the Tier 1 capital and the total capital -- risk-based capital, where the impacts of the corresponding deduction approach will impact us, and I don't have those numbers in front of us, but James actually has pulled them out. So we'll give you some -- probably some of the estimates.

James R. Abbott

Yes, they would be almost identical, Dave. The -- I'm a little hesitant to give the number that I'm sitting on right now because of -- we're still finalizing it, but the difference between the Tier 1 common and the Tier 1 total is only about 5 basis points different.

David Rochester - Deutsche Bank AG, Research Division

So really no change from the last quarter then.

Doyle L. Arnold

No.

David Rochester - Deutsche Bank AG, Research Division

In terms of the difference.

Doyle L. Arnold

Correct. But what's happening, the interesting thing is that all of this doesn't start really for another 5 or 6 quarters. In every quarter, we are getting pay downs now on the CDO portfolio. So every quarter, the amount of that other Tier 1 and Tier 2 haircut is being reduced. So essentially, the big picture here is very strong CET1 ratio and then the other ratios, present trends, continue should grow as the CDO portfolio, particularly the senior tranches, continue to pay down.

Harris H. Simmons

Yes. And, David, we actually included a new table in the press release this quarter just because of the paydowns or potential sales of these securities over the course of the next year or 2, might become an interesting part of the story to follow. And so we've included a table on Page 5 of the press release, showing the change in the CDO portfolio relative to the year-ago period. It doesn't change fast enough to show, compared to the prior quarter, but compared to the year-ago period. So the par value is down about $175 million, which is -- that's helpful, obviously, to the corresponding deduction -- calculation. So we've seen the AOCI improvement, on a pretax basis, up about $260 million. So given that...

Doyle L. Arnold

But the reason that asset is important is the reduction of amortized cost of $259 million.

Harris H. Simmons

Yes.

Doyle L. Arnold

Okay?

David Rochester - Deutsche Bank AG, Research Division

Yes, got you. So I guess it's just the way you think you're going to have to calculate those ratios today, 1 to 2 years from now, are you comfortable with that calculation in those levels?

Harris H. Simmons

Comfortable, well...

David Rochester - Deutsche Bank AG, Research Division

In terms of the overall level for Tier 1 capital ratio and whatnot?

Harris H. Simmons

CET1, yes. Tier 1, I mean, frankly, if it were fully phased in today it would look, despite having on a Basel I basis, over a 2.3% of RWA is preferred stocks, for example, on a Basel III basis fully phased in, we would be quite light, relative to peers, instead of being heavy in that, relative to peers. So I'm not -- frankly, we're not anxious to issue more preferred or sub debt to -- particularly preferred, than we have today. So I think we're going to ride with it and see if that CDO portfolio doesn't continue to improve. And frankly, we've got get over 1 year before that phase-ins starts, and then 3 more years after that. And our projections show that under a reasonable, very modest continued recovery, we will see a lot of movement in the amortized cost and the fair value of that portfolio over that time period.

Operator

The next question comes from Keith Murray from ISI.

Keith Murray - ISI Group Inc., Research Division

Could you just talk a little bit, you and many other banks are seeing pretty healthy growth in commitments and yet utilization rates are near historical lows for most. What is sort of the disconnect there? And when these companies are adding to commitments and taking out new commitments, what's sort of the dialogue? What are they indicating why they're not using it? Just curious there.

Harris H. Simmons

I think the reason why they're not using it is uncertainty. Because I think there -- that's not always the case, but in the C&I world, it actually costs you money to take out a new commitment and then sit on it. So there has to be a degree of caution, uncertainty and conservatism on their part if they may be viewing it, in some cases, to some degree, as an insurance policy.

Doyle L. Arnold

Yes. I mean, the only thing I would add is locking into some certainty with respect to rate.

Harris H. Simmons

Yes.

Keith Murray - ISI Group Inc., Research Division

Okay. And then...

Harris H. Simmons

Wish I had -- gee, I hadn't thought of that answer for you, but I don't.

Keith Murray - ISI Group Inc., Research Division

Fair enough. And just -- you had a little bit of OTTI again on the [indiscernible] CDO portfolio. When you think about the rating agency view of that portfolio and where you'd like to be down the line on debt costs, do you think you're getting closer to an understanding there, or is it still a ways off?

Harris H. Simmons

The -- oh, I got a -- I went down the wrong path there trying to follow your question. So let me comment in a couple of respects. Yes, we did have additional OTTI this quarter. Not all that much in the grand scheme of things. Primarily resulted from a changed model for evaluating OTTI and fair value in which we -- the main driver of the increase was a new variable in the model, in which is how long -- time and deferral. How long has a deferring bank been deferring? And the reciprocal of that is how much time does it yet have to cure? The theory being that the longer it's been deferring, all other things being equal, there must be something the regulators or somebody is concerned about that we can't observe and, therefore, the probability that it might not cure goes up. So between -- I'll just say, between kind of that change and the fact that a number of banks are curing themselves and dropping out of our deferring bank pool, we have ratcheted up the weighted average default probability and the remaining pool from about 44% fourth quarter a year ago to 66% this quarter. In other words, the good have gotten better and dropped out of the pool, and we've gotten a little more conservative on some of those remaining in the pool. That -- but that latter, the getting more conservative, drove this and that was kind of a onetime change in our model. The rating agencies are kind of split on the securities themselves. Moody's and Fitch have been regularly upgrading a number of these securities, sometimes by -- a matter of fact, most times by multiple notches. S&P has been the lagger here. They have -- they seem to have a pattern of not upgrading a security until shortly before it actually pays off, which strikes us as being a little strange. But...

Doyle L. Arnold

Very conservative.

Harris H. Simmons

Oh, yes. Very conservative. And with regard to -- if you were asking a question about -- with regard to our own ratings, Zions Bancorp's ratings, yes, I think it's still a concern, but as the portfolio reduces in size, it's still very, very large. But -- it's becoming less of a concern, but it's still a real concern. And how much varies by agency, do you want to comment any further, James?

James R. Abbott

I was just going to say we've got about 4 minutes remaining, so we're going to shift to the lightning round. [Operator Instructions]

Operator

The next question comes from Steven Alexopoulos from JPMorgan.

Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division

So historically, Doyle, you spoke of needing, I think it was $400 million or $500 million a quarter of loan growth off of the asset yield compression. Given the outlook for a fairly tepid growth and it seems that more of the growth is coming from lower-yielding loans. Can you help us think about the magnitude of margin pressure you would expect at least over the near term?

Doyle L. Arnold

Well, I actually ratcheted down my $400 million to $500 million to, maybe, $300 million to $400 million based on the -- knowing that some of the sources of margin pressure were going to be abating by third quarter of this year, namely, some of the -- the bulk of the repricing of the National Real Estate portfolio that was made in kind of first half of 2008, and 2 years prior to that would be behind us and a couple other things. However, it does appear that there's been some -- you're right, the new loans makes us a little less rich from a margin standpoint. And there seems to be some renewed, more -- the pricing pressure, just in general, has not abated as we thought we might. So yes, it might take still $400 million to $500 million to keep the margin stable, and it's not clear in this environment that we will get it, hence our slight softening of our net interest income guidance.

Operator

The next question comes from Brad Milsaps from Sandler O'Neill.

Brad J. Milsaps - Sandler O'Neill + Partners, L.P., Research Division

Just a question on credit quality. It sounds like you guys feel pretty positive about where things are. Just the pace of the reserve release, maybe less this quarter, given your positive comments around credit, relative to the first and second quarter, just any additional color there and what you think -- how quickly you draw that down as you move into 2014?

Doyle L. Arnold

No, I don't think we're going to change our fundamental posture. The -- setting aside the unfunded lending commitment change, the drawdown on the ALLL was actually the smallest this quarter than it's been in at least 1 year. No particular thing driving that. I would expect some -- probably, unless something changes, my guess is the reserve release would look more like the prior quarters, on the ALLL, than the current quarter, at least for the next 2 or 3 quarters. Something in the $15 million, $20 million-maybe range. Just a guess, the calculations will be what they will be toward the end of the quarter. But based on the trends, that's kind of what my gut tells me.

Harris H. Simmons

I would just comment, if you -- I think, if you added the RULC and the ALLL release this quarter, it about averages what the total ACL change has been for quite a few quarters now. So the unusually large RULC was coincidentally offset by a smaller ALLL. But I would guess the total would still be kind of in that higher range.

Operator

The next question comes from Ken Usdin from Jefferies.

Kenneth M. Usdin - Jefferies LLC, Research Division

As we get into you guys moving into CCAR from CaPR this year, and you have -- you got through the Series B and Series C. I'm just wondering how you're thinking about the prioritization of either putting in for more of these sub and senior debt redemptions as you go through CCAR, versus your other potential uses of capital return as you think about CCAR now going in with a 10% plus Basel III ratio?

Doyle L. Arnold

Are you trying to get me to -- I don't think I want to go there because we haven't really had those discussions. I would note that the -- about the only expensive capital that we have haven't addressed yet was we've got -- we tendered for about as much senior debt as we could get. There's probably not much point in doing another tender. It matures in the third quarter of next year and just pay it off and replace it with cheaper debt would be the logical thing to think about. And with regard to the sub debt, that matures in '14 and '15, depending upon the issue. We'll look at tender premiums and whatnot as a part -- and that possibility as a part of our capital plan and see if it's worthwhile to accelerate any of that. But you've got $0.5 billion -- it's over $0.5 billion between the modified and unmodified sub debt that's still out there and pretty expensive. In terms of where I won't go is in terms of common equity, stock buybacks, dividend increases. I'm just going to defer on that totally until we go through the process.

Operator

The next question comes from Erika Najarian from Bank of America.

Erika Najarian - BofA Merrill Lynch, Research Division

My one question is if the revenue environment continues to be soft for the industry into next year, is there room to lower that $400 million quarterly expense run rate that you mentioned we should model for you in 4Q?

Doyle L. Arnold

No. I mean, not materially. We've got so much -- we're lowering it where we can. And regulatory assessment costs and things will be lower next year than this year. But realistically, I think -- maybe not quite as much on consulting expense next year as this on CCAR, but I think, if any of our consultants are listening in they'll be delighted by this comment, I think we'll still have them around, to some degree, next year because we just frankly won't get everything done to the level we need to on CCAR this year. And the core upgrade and accounting systems upgrade projects will -- the increased spend on that will kind of offset for the next year or 2 at least, maybe several years in the case of the core project, the improvements that we expect on some of those other fronts: litigation expense, regulatory assessment expenses, et cetera.

Harris H. Simmons

We have a question coming in from email related to this. From an expense perspective, does that $400 million guidance include the FDIC indemnification asset expense? And the answer to that is yes, it's an all-in expense number.

Operator

The next question comes from Gaston Ceron from Morningstar Equity.

Gaston F. Ceron - Morningstar Inc., Research Division

Just real quick here, I just want to go back to the issue of credit quality for a second. I don't know if you dug into this and I missed it, but with the charge off ratio, I think you said 9 basis points and with the allowance, I think it's 2.3%. How are you guys -- have you guys changed your mind on sort of what a long-term normalized level would be for these measures, or are you still kind of thinking the same?

Doyle L. Arnold

Well tell me what you think we were thinking, and I'll tell you if we changed our mind.

Doyle L. Arnold

I don't want to answer that question quite that vague. Where do you think we've guided you? And then I'll tell you.

Gaston F. Ceron - Morningstar Inc., Research Division

Well, let me rephrase it then, how are you thinking about the long term normalizing?

Doyle L. Arnold

Oh, touché. Okay. I -- long term, to me, includes a probable change from an incurred loss to an expected loss model to occur sometime in 1 to 2 years out. And I would expect that for us and the industry to result in reserves higher than -- for the industry, higher than where they are now, for us, probably something more like where we are now, something in the low 2% range. If -- but until that happens, and we're under the current incurred loss model, I would expect, with this kind of credit quality, our total ACL, which I believe was 2.3% this quarter down from 2.4%, to continue to come down every quarter, probably until there's nothing else changed, it's probably on a glide path to get in the mid -- to 1.5% to 2% range, somewhere like that, kind of where a lot of others are.

Harris H. Simmons

We continue to include kind of the peak-loss years as we get further out in time. It's becoming less and less weighed in its algorithm so that's one of the things that's happening here.

Operator

The final question comes from Gary Tenner from D.A. Davidson.

Gary P. Tenner - D.A. Davidson & Co., Research Division

Just on the release of the provision for the reserve for unfunded lending commitments, is that figure calculated on a kind of a strict look back of average utilization levels, or is it really based on a little more of your expectations and feel for kind of where things are going to go over the next, say, 6-12 months?

Doyle L. Arnold

Well, the ALLL component is based on outstandings. The reserve for unfunded lending commitments is based on the unfunded portion. Both are based on look-backs. As Harris kind of briefly mentioned, we're basically, in both cases, taking our actual experience from the beginning of 2008 right up through the most recent quarter, and every quarter we're adding 1/4 to look at loss rates by loan type, by geography, by credit grade. And so as any of those things changes, it changes the quantitative portion of the ALLL. And then the additional factor for the unfunded lending commitment reserve is what the expected utilization rate is. That -- we don't change that every quarter, we kind of made a onetime change from something like 45% average, previous quarters, to something in the low 30%s this quarter based on the experience that we've had here. And kind of that's the way it's done, and then on top of that, we have a qualitative portion that's derived from another number of judgmental things. We frankly haven't changed much in the last few quarters, those judgmental qualitative factors. So the changes you're seeing are driven primarily by the quantified part of the reserve. Does that tell you what you needed, or more, or less?

Gary P. Tenner - D.A. Davidson & Co., Research Division

Yes, that's very helpful. I appreciate it.

Harris H. Simmons

Well I think we're about done. James, do you want to wrap us up?

James R. Abbott

Thank you very much for joining the call today. We will be happy to take further questions from you. If you do have them, please call me or drop me an email. Thanks so much, and we'll talk to you again next quarter.

Operator

Ladies and gentlemen, that does conclude the conference for today. Again, thank you for your participation. You may all disconnect. Have a good day.

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