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Zions Bancorporation (NASDAQ:ZION)

Q2 2014 Earnings Conference Call

July 21, 2014 17:30 ET

Executives

James Abbott - Senior Vice President, Investor Relations and External Communications

Harris Simmons - Chairman and Chief Executive Officer

Doyle Arnold - Vice Chairman and Chief Financial Officer

David Hemingway - Executive Vice President, Capital Markets

Scott McLean - President

Analysts

Brad Milsaps - Sandler O'Neill

Steven Alexopoulos - JPMorgan

Joe Morford - RBC Capital Markets

Ken Zerbe - Morgan Stanley

Jennifer Demba - SunTrust Robinson

John Pancari - Evercore

Ken Usdin - Jefferies

Dave Rochester - Deutsche Bank

Geoffrey Elliott - Autonomous Research

Brian Klock - Keefe, Bruyette & Woods

Kevin Barker - Compass Point

Operator

Good day, ladies and gentlemen and welcome to the Zions Bancorporation Second Quarter Earnings Call. This call is being recorded. I will now turn the time over to James Abbott. Please go ahead.

James Abbott - Senior Vice President, Investor Relations and External Communications

Thank you. And we welcome you to this conference call to discuss our second quarter of 2014 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 one hour, which will include time for you to ask questions. During that section, we ask you to limit your question to one primary and one follow-up question to enable other participants to ask questions.

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

Harris Simmons - Chairman and Chief Executive Officer

Thank you, James and we welcome you to the call today. We continue to make substantial progress on a variety of fronts, including credit quality, certain elements of fee income, generally stable net interest margin and net interest income. We are also making solid progress on efforts that are taking place behind the scenes, including the ongoing and significant upgrade to our risk and credit management practices, which is a process that has been going on for sometime now since it’s a crisis and an area where great progress has been made, but there is always more to do.

A key challenge for Zions is holding the expense level at or near current levels at a time when the current interest rate environment has placed the pressure on net interest margins across the industry. And when the systems need to be replaced and we continue to need to invest to meet increasing compliance, stress testing and other regulatory requirements. Although all banks face the spread compression challenge, Zions is somewhat more sensitive to his pressure than some of the nation’s largest banks, because spread income is a larger portion of our total income statement or total revenue.

Turning to the financial results for the quarter. Net interest income, excluding the income from FDIC indemnified loans, increased about $7 million or about 2%. As we have guided in the past, loan growth and reduced debt expense acted as offsets to natural pressures from loan pricing pressure and the declining source of earnings from loans purchased from the FDIC back in 2009 are so-called covered loans. With regard to loan yield pressure, the primary challenge has been new loans coming on at yields that are below those of loans that are rolling off. The competitive pricing environment has been difficult for all banks, although in many of our markets and lending types, we are experiencing some stability in marginal pricing.

Regarding volume, we experienced healthy average and period end loan growth in the second quarter and origination volume increased slightly over the same period a year ago, up about 2%. Our managers and those involved in our small business lending are seeing improved demand and higher approval rates in their – in this particular area of small business. And middle-market commercial and industrial and consumer demand remains reasonably healthy. Commercial real estate lending demand in our markets is reasonably strong. Although as we have discussed in this forum in the past, we are limiting our growth in commercial real estate as part of our concentration risk management practices as well as the very high capital requirements, when you consider the capital required to support such loans for those of us that are subject to Dodd-Frank Act stress tests.

We are hearing from our lenders that some of the other large bank competitors in our markets are backing away from the loan type that receives the most significant losses in the stress test, in this case, the construction and land development category. So, we probably are not alone in this redirection of capital allocation. Although Zions construction and development loan balances grew in the second quarter, commitments declined. Our loan growth outlook remains unchanged on the whole and that is for slightly to moderately increasing loan volumes.

Credit quality is strong and the trends are generally stable to improving. Our loan net charge-off ratio remains one of the best in the industry at 6 basis points and total loans on an annualized basis. Non-performing assets improved by about 14% from the prior quarter and equaled 95 basis points of loans and REO the first time it’s fallen below 1% since 2007. Classified loans declined about 5% in the quarter.

With respect to capital, our GAAP common equity capital ratios increased compared to the prior quarter with a tangible common equity ratio rising to 8.6% from 8.2% last quarter, primarily due to the cancellation of our total return swap on our collateralized debt obligation portfolio. Our Tier 1 common equity ratio under Basel I declined about 14 basis points to 10.42%, which is in line with information I previously communicated to you. Finally, let me note that I suspect that many of you are anxious to know more about the Federal Reserve review of Zion’s stress test and capital plan resubmission. As indicated in our 8-K filed on July 14, we currently expect Federal Reserve to provide a response to our resubmitted capital plan by July 28.

With that overview, I will now ask Doyle to review the quarterly financial performance. Doyle?

Doyle Arnold - Vice Chairman and Chief Financial Officer

Thank you, Harris. Good afternoon everyone. A brief overview for the second quarter 2014, Zion’s posted net earnings applicable to common shareholders of $104.5 million or $0.56 per diluted common share. This compares to net earnings applicable to common of $76.2 million in the prior quarter or $0.41 per diluted common share. There were kind of two big swing items between the quarters. First, recall that first quarter results included a net $31 million pretax gain on fixed income securities that resulted from CDO sales that we did that quarter. That added about $0.10 per share to earnings in that quarter and a higher preferred dividend level that quarter reduced earnings by about $0.05 a share.

The other big swing is in the second quarter due to continued strong improvements in credit quality that was referenced by Harris earlier we had a net negative provision for the combined – combination of funded and unfunded lending commitments of approximately $448 million negative. There is one other much smaller item that some of you will want to be aware of. We have a one-time or specific tax accrual of about $2.3 million or $0.01 a share this quarter related to some older tax years which we do not expect to be included in the tax line going forward.

Now, I will move on to a brief review of some of the key revenue drivers. Average loans held for investment increased $419 million compared to the prior quarter. Period end loans held for investment increased a similar amount $432 million. The primary increases were driven then by commercial and industrial loans of $293 million and consumer loans primarily residential mortgages of $103 million.

We are experiencing loan growth in July and expected to continue based on reports from various lending groups. But as kind of indicated in Harris’ opening remarks, we are constraining loan growth in some cases by self imposed risk concentration limits particularly on some types of commercial real estate loans. If we did not have these risk management limits, but we do, loan growth rates would be stronger as there is demand out there. In part because of the concentration limits we were able to be more selective on the deals that we do accept and it enables us to be somewhat slower to cut pricing or to loosen underwriting standards when we encounter that kind of market price pressure.

I also mentioned here that the increase in construction land development loans in the second quarter were solely attributable to draws on existing lines. By design, we slightly reduced C&D commitments in the second quarter and trying to continue to at least in the near-term constrain C&D commitment growth given the very significant equity requirement on such loans in the CCAR stress test process. We are encouraged by recent reports that the outlook for capital expenditure for both large and small businesses appears to be on the rise. The managers of our small business lending units are notably more optimistic about loan growth in that space. And in some markets such borrowers are becoming more active. Managers of larger C&I credits report that customer optimism is about the same as it was a few months ago. And then in that area, our pipelines are generally stable with levels back in March. Managers of commercial real estate products are reporting the market remains quite robust, although there is generally less demand for new multi-family construction than in the past.

Turning to new production volume, that increased approximately 2% from a year ago. We are encouraged that pricing on new loan production has remained essentially stable for the last four quarters. The yield on the loan portfolio, excluding the FDIC supported loans, declined only 2 basis points in the second quarter to 4.28% from 4.30% in the prior quarter. The coupon on new production does remain below the weighted average coupon rate of the existing portfolio however. Therefore, we do expect additional compression for the next several quarters. Although as the portfolio yield converges with the production yield, the rate of compression should moderate. Line utilization rates on revolving C&I loans were up slightly to about 33% from 32% in the prior quarter. Small C&I loans defined as commitments less than $5 million accounted for the increase, where the utilization rate of 40% this quarter, up from 39% in the prior quarter.

Let me discuss for a moment the FDIC supported loans and the income from that source as I have done in the past. We continue to experience quite strong performance on the loans in this portfolio. Payoff amounts and recoveries are in excess of estimates used in previous cash flow analyses, which are updated quarterly. Such pay-off and recovery activity results in accelerated income and enhanced yield of FDIC supported and other purchase credit impaired loans. Such loans yield at an annualized 23% for the second quarter, which was very strong, but albeit down from 29% in the first quarter or about $16 million of total interest income. That’s about 3% of total interest income, yet the loans represent just 0.5% of total interest earning assets.

At the beginning of this year, we expected the total remaining income from the portfolio to be roughly $80 million. The substantial majority of which would be recognized by the end of next year that is 2015. The updated number now is approximately $100 million, of which about $39 million has been recognized in the first half of the year. Current expectation is for roughly $15 million for the remainder of 2014 between $15 million and $20 million in 2015 with the remaining accretion expected to occur in years after that. However, these estimates are subject to revisions that may continue to be significant depending upon basically the underlying strength of the market for the disposition of loans and recoveries on loans in that portfolio.

The indemnification asset expense related to this loan book, which is recognized as a component of other non-interest expense equaled $9 million for the quarter, down from $16 million in the prior quarter and should amount to a total of about $6 million in the third quarter. And going into periods beyond the third quarter, if FDIC supported loan cash flows exceed our current forecast, we will recognize additional both revenue in the form of interest income and the related expense in the other non-interest expense line, the revenue will exceed the expense, however, kind of no matter what, just the amounts of both may vary. For example, if we experienced $10 million of cash flow in excess of our current forecast over several quarters, we would recognize $10 million of interest income over that timeframe and about $8 million of non-interest expense over the same timeframe which is the FDIC’s portion of the cash flow. I wish we didn’t talk so long about that item but I know it’s a source of noise that some of you try to back out of your estimates.

So we will move – now move on to the overall margin and net interest income. Turning to the net interest margin on Page 13 of the release you will note that the NIM declined two basis points compared to the prior quarter. Looking at the primary drivers reduced income from the just discussed FDIC supported loans reduced the NIM by about six basis points and lower income from available-for-sale securities reduced it by about three. But offsetting this, a lower balance in cost of long-term debt enhanced demand by about three basis points. And the change in the mix of the asset base higher balance of loans and a reduced the balance of cash provided about four basis points of NIM support.

As previously mentioned the yield on loans declined two basis points to 4.28% from 4.30% in the prior quarter. Yield on commercial loans was very stable compared to prior quarter 4.3% versus 4.29% last quarter, as of the consumer portfolio 4.07% versus 4.09%. The loan type showing the most significant compression was the construction and land development portfolio which declined to 4.33% from 4.63% or 30 basis points. And the yields on those types of loans are fairly similar to those in the C&I portfolio at this point.

On Page 9, total net interest income was $416 million, which was essentially unchanged from the prior quarter and I think in line with the guidance that we have been giving you throughout the quarter. Although we ceased building a core net interest or providing a core net interest income we have committed to giving you components so that you could continue to calculate it if you wish to do so. And we will do so for the remainder of this year. The additional accretion on FDIC supported loans is found on the table, bottom of Page 9. It equaled about $11.7 million. The discount amortization on subordinated debt was $6.5 million. Adjusting for these factors there was about $5 million linked quarter increase in net interest income. The net interest margin if one adjusted for these factors actually increased slightly.

Turning now to non-interest income on Page 7, after we and many other banks experienced a very soft first quarter in fee income ours and some others bounced back a bit here in the second quarter, other service charges, commissions and fees in particular increased to $47.5 million, up from $43.5 million in the prior quarter and compared to year ago period is up about 3.5%. Much of the increase is due to our efforts to improve penetration of business credit cards. The fair value and non-hedged derivative income line increased by about $6 million to a negative $1.9 million from the prior quarter, this was primarily the result of the cancellation of the total return swap in late April which we advised you of both before and at that time. We do not expect any further contra revenues from that item in the future quarters.

Regarding fixed income security gain – securities gains, although we did not sell any CDOs in the second quarter, we recognized a gain of $5 million. This occurs when we have taken other than temporary and common charges in the past or if we purchased securities at a discount par in the past which we did when we bought those – some securities out of Lockhart Funding, our off-balance sheet QSPE back in the period 2007 to 2009. Anyway if those securities now payoff at par, they are paying off at a price that’s higher than the market value. And this quarter, we received par value pay-downs of $24 million as seen on Page 8 of the release resulting in a gain of $5 million. We currently expect this to be an ongoing source of income although it maybe a bit sporadic in nature. Assuming the economy remains relatively stable our models indicate that we should receive almost all of the par value of the performing CDOs if we held them to maturity or about $60 million of gains.

Our models also indicate that we should end up recognizing values greater than amortized cost on non-performing CDOs, but it’s substantially less than the par value of those CDOs. And the realization of that income would likely take many – being many years in the future assuming we continue to hold them for that long. Although we may hold these securities to realize some of the gains I just described, we may also elect to sell some of them from time-to-time in order to maximize our capital ratios under the stress testing process, a well-defined benefit today in exchange for a less certain benefit sometime in the future.

Finally, non-interest expense turning back to Page 7 most of the line items were fairly flat compared to the prior quarter, with three exceptions. Salaries and benefits increased by $5.4 million. Seasonal expense declines for payroll taxes were offset by an expense that occur seasonally every second quarter, which relates to stock grants to certain employees. Those, in fact, just so you understand the stock grants for employees who are eligible for retirement and would best continue to vest into retirement are expensed immediately, because effectively, the employee could elect to retire and have those grants fully vest over time. So, that’s a pop that occurs when we make those annual grants in the second quarter.

Base salaries increased in part due to normal cost of living increases, but also as a result of increased staffing related to risk management compliance and the various systems replacement and enhancement projects that we announced a year ago. We have indicated that we are attempting to keep overall non-interest expense levels flat during this process. We expected salary levels in some professional services to increase to reflect this offset by declines in the indemnification asset expense and other credit-related costs. We are still staffing up for some of those projects and expenditures should increase somewhat over the next six quarters and then begin to decline in 2016.

Finally, I have already addressed the indemnification asset expense, which is contained in the other lines. If you strip out the indemnification expense, other non-interest expense increased only slightly compared to the prior quarter.

Let me wrap up now with summary of our outlook and guidance for the next year forward or so. Loan growth will remain – maintaining our slight to moderate growth outlook for loans over the one year horizon, although loans have continued to grow thus far in July, we don’t expect third quarter growth to be quite as strong as the second quarter as we see it unfolding currently.

Net interest income on a GAAP basis, including the effect of the expected decline in interest income from the FDIC supported loans we expect to remain relatively stable. Pressure should come from further declines in those FDIC supported loan net interest income and as loans maturing that are replaced with loans at lower yield. As we get further out into 2014 and early ‘15, we expect that loan growth and higher cost, senior and subordinated debt payoffs will offset much of that pressure. Excluding the FDIC supported loan income we expect net interest income to increase slightly over the next year.

Non-interest income, we expect the less volatile components such as service fees to continue a modest upward trend as we push further into the mortgage space and enhance our treasury management product penetration. I mean for non-interest expense we – as I have mentioned we are attempting the hold non-interest expenses relatively stable at around $1.6 billion annually. We continue to hire for systems initiatives and regulatory and compliance-related jobs and expect our full-time equivalent employee base to increase by approximately 1% to 2% over the next year. Some of that – some of the expenses of those employees will be capitalized and somewhat offsetting the expense increases should be continued reduction in credit related expense and FDIC indemnification asset expense amortization.

During the provision expense, given our expectation of continued improvement in metrics that drive our ALLL methodology, we expect the provision expense to remain negative in the near-term. The current debt equity, I will just note that for those who are trying to figure out what to do with that line item, the first quarter’s reserve release was probably a bit usually on the low side, while the second quarter’s release was probably a bit on the high side if you are trying to – it probably somewhere in their brackets the target if you are trying to build a model. But I don’t have any particular number in mind, I hasten – I must hasten to add that just trying to point the way things look. The tax rate as I mentioned was slightly elevated in the second quarter from that one item and we expected we will run a bit closer to 36% for the balance of the year. And finally deferred dividends should run around $15 million to $17 million per quarter.

With that I think we will wrap up the opening soliloquies and operator would you open up the lines for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Brad Milsaps with Sandler O'Neill. Your line is open.

Brad Milsaps - Sandler O'Neill

Hi, good afternoon.

Harris Simmons

Hi Brad.

Brad Milsaps - Sandler O'Neill

Doyle, just want to ask about the balance sheet, some of the – you talked a lot about the reduction in cash, but looking at the deposit base, foreign deposits came down quite a bit in link quarter, can you talk a little bit about that and some of the movement you might see in the liquidity as you look out over the back half of the year, what your plans might be there, how they may have changed?

Doyle Arnold

We debated about whether to talk about deposits in the opening remarks and wait or wait for the question and the question is number one. So there were two – there were kind of two unusual items in deposits. One, is we closed a Cayman Islands branch which reduced the foreign deposits, but they were all re-booked domestically. So if you look at I believe it was mostly went into savings and now accounts, was it David. Savings and money market accounts, so that line item increased slightly, so that was just a shift. We did the next reduction in deposits of I think it was between $800 million to $900 million was driven primarily by the departure of one large institutional customer that we had – it was a college savings plan customer that we effectively no bid the renewal because it was costing more than deposits were worth. So and there was no other real relationship with that party. So it was a result of decision that we actually had plenty of liquidity and so we exited. That was our choice to exit that account. I will give you a chance to follow-on on that one if that was clear.

Brad Milsaps - Sandler O'Neill

No thanks. Maybe just to follow-up just in terms of liquidity, the $7.5 billion of money market on average I guess was down to a little more than $6 billion on a period end basis, any change in how you are going to manage that going forward?

Harris Simmons

No, I mean we are beginning to track against some of the new liquidity metrics that will become binding I think in January, particularly liquidity coverage ratio, we don’t – the final rules are not yet published as you know, but as best we can calculate, we think we are in pretty good shape on that metric, but there is a lot less than $7.5 billion of true excess liquidity that we will have to hold a number of billions of dollars of liquidity in the form of cash or very low risk, very liquid assets like treasuries, for example, going forward anyway. So, I think the best outlook is that loan growth will continue to erode into that cash amount at an incremental rate, but there are no plans given the flatness and lowness of the yield curve to move a lot of that cash out. David, would you – anything you would like to add on that?

David Hemingway

No, I would agree with that.

Harris Simmons

Okay.

Brad Milsaps - Sandler O'Neill

Okay, great. Thank you, guys.

Harris Simmons

Yes.

Operator

Our next question comes from Steven Alexopoulos with JPMorgan. Your line is open.

Harris Simmons

Hello, Steve.

Steven Alexopoulos - JPMorgan

Regarding the stress test, Harris in your prepared comments you indicated larger banks directing capital away from C&D loans, based on what you guys are seeing from this stress test is now resubmissioned, is there anything you had flagged for us as a change in the way you guys plan to run the business?

Harris Simmons

Well, I just – I mean I just underscore what both Doyle and I, I think said that is that one of the things we are certainly focused on is the capital consumed by construction and development. And so we are actively trying to manage down exposures there. Ultimately, it’s a business that will always be in here in the west. It’s an important line of business to us. And we may find other ways to conduct some of this business through and originate and sell kind of the model, but that in particular is a near-term focus. We are interested to see the results – our own results and those of the Federal Reserve in the 2015 CCAR exercise, that will probably provide some additional color to us in terms of how we are going to think about this, but we do understand that commercial real estate generally is consuming more capital than some of the other loan types in the context of stress tests. And so we are trying to think about that accordingly as we establish concentration limits.

Doyle Arnold

I just add if you go back to the Federal Reserve’s published CCAR results for all the banks, the stress losses on commercial real estate loans were pretty high compared to other types. And while the Fed does not provide a breakdown between construction and development and term and owner-occupied, we and investment banks and consultants have all tried to estimate what that breakdown might be. And it looks like that construction and development are maybe doubled or more, the loss rates that the Fed published is for overall CRE, which makes it pretty painful from a capital utilization standpoint relative to as I mentioned pricing that has actually come down over time. And so that’s what we are dealing with.

Steven Alexopoulos - JPMorgan

Maybe to follow up what’s your annual spend running now tied to compliance-related cost as a CCAR bank and are you at a stage now where it sounds like you are still building on that, we shouldn’t be thinking of any room for efficiencies here at least over the near-term?

Harris Simmons

Well, I think it’s – this is Harris, but it’s the slope of the line is leveling I think. I mean, it’s not – we are not adding at the pace that we were two, three years ago, but it’s – and it’s actually something that I would be reluctant to try to nail down an actual cost. We have added, I mean the last time I tried to track this, we have added something over 300 full-time equivalent staff. This sort of this goes back about a year ago and that was over the prior couple of years, that numbers continued to grow, but not at the same pace. So if you read some of speeches by Federal Reserve governors particularly Governor Tarullo, lately he indicates publicly what we are experiencing directly which is the Fed’s level of expectation, it does continue to grow – increase. And it would appear you have got another maybe another couple of years of continued heightened expectations. Well, not having to add as much staff to meet those expectations, just redeploy them into addressing the current year’s level of top concerns is they are expressing to us in the industry. I don’t know if that makes – if you follow that but that’s we are all – they describe it as a glide path upward to a spot they want us all to get to.

Doyle Arnold

I would just – I would only say I mean heightened expectations I think is always going to be with us, that’s just a new environment that I think all banks sort of find themselves in. I think in a couple of years that (Joel) is talking about is probably a couple of more years of some building spend. We also as we have talked about some of these big systems projects, we are becoming more encouraged as we get those in place that we will be able to see some savings and so we see some silver linings on the horizon.

Steven Alexopoulos - JPMorgan

Okay. Thanks for all the color.

Operator

Our next question comes from Joe Morford with RBC Capital Markets. Your line is open.

Joe Morford - RBC Capital Markets

Hello. Good afternoon.

Doyle Arnold

Hi Joe.

Joe Morford - RBC Capital Markets

I guess I was just curious if you could give us any color on regional trends in loan growth this quarter?

Doyle Arnold

You want to talk about that James.

James Abbott

Yes. Joe this is James here. I would say we saw really the strongest growth came from the Amegy and the Utah banks. Utah had a very strong C&I growth in the quarter. On the small business front in Utah there was a lot of optimism today. Just really a good overall market I believe the unemployment rate in Utah is 3.6.

Doyle Arnold

3.5.

James Abbott

3.5 that is going, and so it’s been very strong on those fronts. We saw a very good consumer loan growth across most of the franchise. So it really is pretty a broad based growth. And so I would just say that a couple of the areas that we did experience some attrition is on obviously on term commercial real estate. Some of that was in actually was across some of the several places in the footprint we did experience growth in construction and land development across about four or five of the affiliate banks. And but again the commitments have come down in virtually all of the affiliate banks compared to prior quarter.

Joe Morford - RBC Capital Markets

Okay, that’s helpful. I guess the other question is just a couple of things on expenses, I have recognized some of the finance bounce around, but provisions around funding commitments was up from last quarter to a slight recovery though the overall level of commitment seem like it was stable, so wondered what was going on there maybe something unusual last quarter. And then similarly with the elevated provision on legal services now that we are through the resubmissions, do you think we will start to see that level start to tail down a little bit?

Doyle Arnold

I would think in order provisions for unfunded lending commitments, is it gets moved around by a number of things. There were actually some very late quarter increases right at the end of the quarter increases in commitments last quarter that weren’t picked up in our methodology. They were not deemed material but that added – basically it did add to the provision for unfunded commitments this quarter. We had a little bit of deterioration in one credit quality metric in a couple of loans, but there is no – I think the best thing I could tell you there is that overall in this environment, the growth – the provision for unfunded commitments ought to be somewhere around zero to a very small positive number with the driver being growth in new commitments or unfunded commitments driving the number to be positive and continued improvements, general improvements and credit quality pushing it back down towards zero.

On consulting and legal and whatnot, yes, the resubmission is in, but we like all bank sales, as I mentioned, a number of to do items from – as a result of the last CCAR – the Federal Reserve expects further qualitative improvements out of all banks and so we are spending to address those further improvements in our stress testing processes. I do think the rate of spend on that will be less this year than last and it should be less next year than this year.

Harris Simmons

And I’d just note that, I mean, this quarter last year was $70.1 million, that’s actually down $5 million from where it was in this quarter last year and that does reflect the fact that we’re spending less on CCAR related pretty much, but it’s going to be there probably for a while as we continue to refine that process.

Joe Morford - RBC Capital Markets

Okay, that’s helpful. Thanks guys.

Harris Simmons

Yes.

Operator

Our next question comes from Ken Zerbe with Morgan Stanley. Your line is open.

Ken Zerbe - Morgan Stanley

Hi, guys.

Harris Simmons

Hi, Ken.

Ken Zerbe - Morgan Stanley

I guess first question is just in terms of the small business demand, it seems like you guys have mentioned that small business demand has picked up or is picking up for last several quarters. How much of the loan growth this quarter actually came from what you defined as small businesses versus the larger businesses? And also when you are looking into what you are seeing in July sort of same question, what is being driven by small versus larger clients?

James Abbott

What we saw, we saw – Ken, this is James, we saw a pickup in the line utilization rate as mentioned in the press release and it’s although it’s small, it was a pickup, the commitment rate for large business has actually declined. Our syndicated credit balances declined on a linked quarter basis and so – and then in terms of overall production volume, it was up for small business. In terms of balances, I will have to get back to you after the call. I have got a sheet that’s not with me here, but basically the smallest in the $1 million to $5 million size credits with the ones that definitely experienced some of the bigger increases in volume on the production side. And the optimization is definitely – is definitely there, it’s – the approval rates on small business credit for example is probably up 10 to 15 percentage points compared to couple of years ago. And we are now in the 75%, 80% approval rates of those that are applying, so that’s a meaningful increase over the past couple of years.

Ken Zerbe - Morgan Stanley

And what that basically result from is their balance sheets and the income statements have kind of completed the heeling process from the deep recession and there is now built up two or three years of better financial performance that can be years to justify or lending?

Harris Simmons

I don’t suggest, just a little footnote that is we were just named this last week as the recognized as largest SBA lender in the Houston, MSA which is a first for us after working at that for several years and for any of our people listening in it, they kudos for that, but I – that puts us kind of in a lending position in SBA production in Houston and in the state of Utah and up to Idaho, couple of the very best economies in the United States where we are really doing it, I think a really good job with SBA production and that’s kind of a bellwether for all kinds of other small business loans that we are doing in these markets.

Ken Zerbe - Morgan Stanley

Got it, okay. And then a follow-up question just in terms of the potential equity raise after you hear back from the Fed, are you guys in a position that we could actually execute on the equity raise as soon as you hear back or just hoping to get an update on the timing of when that is likely to happen if you had also any thoughts on the form that, that might happen in terms of either dribble out or something else? Thanks.

Doyle Arnold

Yes. I think we are going to – we are just going to defer any discussion of the equity raise until there is one. If there is one and that won’t – we won’t be in a position to discuss that until after we have heard back from the Fed. We all want to avoid tripping over securities law issues about hiking a deal or anything like. So, let us talk that one please.

Ken Zerbe - Morgan Stanley

Fair enough. Alright, thank you much.

Operator

The next question comes from Jennifer Demba with SunTrust Robinson. Your line is open.

Doyle Arnold

Hi, Jennifer.

Jennifer Demba - SunTrust Robinson

Hi. Actually, Joe just took my question a second ago, I tried to queue out, but could you guys talk about – I think you have talked in the last few quarters you have talked about kind of bumping up against your concentration limits in certain categories, notably energy. Can you talk about where you are in that process right now?

Harris Simmons

Well, we have – under the limits we have in place, we still have some room. So, we are not – we are not ducking under the ceiling yet, but….

Doyle Arnold

We were phasing out the growth so that we can manage effectively concentrations and serve good customers.

Harris Simmons

Yes.

Doyle Arnold

Scott McLean sits here with us. So, we will let him.

Scott McLean

Sure. Jennifer, this is Scott. And the concentration limits really are not constraining at the moment. There is a lot – as you know, there is a lot of churn in the oilfield service business and in the reserve base business, in terms of private equity firms selling and repositioning their businesses. And so there is a lot of opportunity to be very active in both reserve base, midstream and oilfield service, while total outstanding, total commitments, they stay relatively constant. There is a lot of opportunity to generate additional income.

Harris Simmons

Yes. I think what I would say is that, I mean limits are, they are causing us to probably think twice about the kinds of – we are not just growing willy-nilly, but there is still room for kind of prudent growth there, but it’s something we watch.

Jennifer Demba - SunTrust Robinson

Thank you very much.

Doyle Arnold

Okay, Jennifer.

Operator

The next question comes from John Pancari with Evercore. Your line is open.

John Pancari - Evercore

Good afternoon guys.

Harris Simmons

Hi, John.

John Pancari - Evercore

On the CCAR front, just a couple of very quick questions there. Just want to see if you have any color on the Fed’s extension request, which I am assuming you may not, but I figured I would ask? And then also on the PPNR differential between where you are expecting and then where you came out, wanted to see if you have got any additional color from the Fed on that front? And that’s my main two things around the CCAR.

Doyle Arnold

Yes. I wish I could provide you color, but I think you heard from us consistently and others, that anything communications related to the whole stress testing in CCAR process, the Federal Reserve considers to be part of their supervisory process and supervisory communication and information sharing is confidential. So, I simply cannot provide you with any color. When we know something more definitive, we will – it would be material and we will have to say something publicly at that time. But in terms of sharing information about the process of getting to that definitive answer, I simply can’t.

John Pancari - Evercore

Alright, that’s fair. But I guess in the – you have mentioned your efforts to control your concentration risk, particularly as you are looking at commercial real estate and as you are doing that, I know you have talked about some considerations, including potential securitizations, potential CDS against your CRE underwriting. Can you talk to us what developments have you completed on that front? How far along the path are you in terms of developing your own securitization capability, how real is that opportunity?

Doyle Arnold

We continue to explore a number of options and there are some that are probably take longer to bring to fruition than other securitization probably falls into the – that’s going to take us a little longer, I mean, may be year or two to really build up the capability and also the pipeline of loans that have all of the standard characteristics that the CMBS type market is looking for. We continue to work on those, but we are also looking at nearer term ways to manage particular concentration risk sold down some of our commitments or portfolio by offsetting portfolios of other types from other players, etcetera. So, you may see more of that kind of activity in the near-term, but overtime I think we remained convinced of what we have here is a strategically as a very high quality commercial real-estate origination capability both for term loans and for construction development loans and we want to not only maintain, but actually grow that capability overtime in a very good market, but it’s going to require developing on those capabilities more robustly to – cannot keep all of that risk on our balance sheet under a stress testing environment so, is that kind of address your question?

John Pancari - Evercore

Yes, it did. If I can access one more quick thing around expenses, Harris, I know you mentioned that you’re still struggling with the expenses here or remained challenges you put it and in terms of your efficiency ratio given your flattish expense expectations, it is fair to assume that the efficiency ratio was relatively stable here at this 74%, 75% level or can we see a come down a lit here in the next couple of quarters?

Harris Simmons

I mean some of the moving parts, the provision lending commitments, you have to take that out, I think that we fair about thinking about the ratio. Beyond that, we’re working hard at some particular elements of non-interest income which we know we need to get to a little higher place we – our fee income mix looks like more like that of probably typical $15 billion bank or doesn’t some of our larger peers. And some of those things take a little time to address, but we’re working really hard on several aspects of that that we think over to the next few years will really help. The big driver is going to be just restoration of more traditional net interest margin levels as interest rates rise. That makes – that’s going to make the big difference is getting back into a little more normal interest rate environment that will really change the number and we are continuing to work at cost control.

And I in the last couple of weeks have been in discussions about probably up to roughly 10 to 12 locations that I would expect that we will probably be closing in coming months or consolidating into other nearby branches etcetera. So, I mean, we are working on that front and doing what we can, but it’s really a numerator, denominator problem rather on the revenue side more than it is, I think on the expense side in terms of what we can address. And we have got and we have some of these systems projects that are going to put some pressure on it for probably the next few quarters, especially until we can start to see some of the cost savings that come along with these projects.

John Pancari - Evercore

Okay, thank you.

Operator

Our next question comes from Ken Usdin with Jefferies. Your line is open.

Ken Usdin - Jefferies

Thanks. Good afternoon. Doyle, I was wondering if you can give us an update on how you are thinking about those higher pieces of higher cost debt, we have got the one coming due this year and then a couple of pieces next year and so can you layout for us whether at this point you just intend to just let those mature and whether or not just normal maturity would cause you to have to also reissue to keep kind of flat on a funding cost basis?

Doyle Arnold

No. Our current expectation, Ken, is that we will pay-off that debt, the senior debt in September and the additional two tranches of sub-debt in the latter half of next year as they mature. And that the total amount of unsecured debt issued by the parent would come down over that time period, but probably we may issue small amounts of senior debt during that process, but the net amount of debt should come down. We are basically going to pay it off.

Ken Usdin - Jefferies

Okay.

Doyle Arnold

No more tenders are expected and we don’t think though it would be very particularly productive.

Ken Usdin - Jefferies

Okay, that makes sense. And then secondly, just from a balance sheet asset side efficiency perspective to your earlier points about the need for keeping excess liquidity and then the uncertainties about deposit outflows. Can you talk about where you stand in terms of just waiting for loan growth versus reinvesting in the securities portfolio in terms of waiting for those final rules and maintaining an adequate buffer on the liquidity side?

Doyle Arnold

I don’t think we have changed our stance really from what we have been saying for a number of quarters now. There are no plans to buy significant amounts of longer dated securities, particularly mortgage-backed securities. I am not saying we won’t do any, but the plan is to incrementally grow loans. And we think that the deposit – at the same time, deposit growth will – which has already slowed down and flattened will likely continue to do so. And we have anecdotally heard of and seen instances of customers beginning to draw deposits down to redeploy cash internally within their businesses. So, we are not planning to go out and invest a lot of that cash.

Ken Usdin - Jefferies

Okay, right. So, you guys just getting up the sort of the governance of slowing the loan growth in pockets does not necessarily make you think about that any differently?

Doyle Arnold

No, because we still expect net loan growth. I think at this point we are probably going to allow one question each we want to get, but defer the follow-ups to James to handle after the call just so we can get – we got about five more people I think queued up. So, we will try to do bam bam bam.

Ken Usdin - Jefferies

Lightning around.

Doyle Arnold

Lightning around, yes.

Operator

Our next question comes from Dave Rochester with Deutsche Bank. Your line is open.

Doyle Arnold

Hi, Dave.

Dave Rochester - Deutsche Bank

Hey, good afternoon guys. Just a follow-up on the cash position, I was just wondering how much excess cash you think you have at this point over which you might need for the LCR and how long do you think it’s going to take for loan growth to use up that excess assuming that your assumptions play out there?

David Hemingway

This is David Hemingway. First is there has been suggested we do not have final rules for the LCR. So, what I have to say is totally based upon our assumptions as to what the final rules might be, but we could have excess cash in the range I would think in the $2 billion to $3 billion range. And so you can actually do the math just how many quarters it would take to chew that up without any loan shrinkage. The big uncertainty is this if and when or when higher interest rates come is the $19 billion of non-interest bearing demand going to stay or are the depositors going to act rationally and pull some of that money out. And those are the issues that we deal with in asset and liability management and liquidity management, so….

Dave Rochester - Deutsche Bank

For how much of it converts into interest bearing?

David Hemingway

Well, how much of it converts into interest bearing and if we need the money we can probably keep it, but if we don’t need the money, it will probably go.

Doyle Arnold

Yes. There is no circumstance under which I would see deposit funding as constraining loan growth, because you can always go out and buy it. Okay. We will move on to the next question.

Operator

Next question comes from Geoffrey Elliott with Autonomous Research. Your line is open.

Geoffrey Elliott - Autonomous Research

Hello, there. So, my question is on the deposit base, particularly the $19 billion of non-interest bearing, what is your latest thinking on how those deposits behave as rates increase, but the interest bearing and the non-interest bearing and then how do you think the mechanism of that tightening in bank’s deposits behavior, whether it’s raising reverse repo rate, raising interest of excess reserves doing something else?

Doyle Arnold

I would, Jeffrey, I’d refer you to the investor presentations that we have given in the second quarter. There are a couple of them out there, one of which at least was filed as an 8-K where we lay out pretty explicitly our thinking and the assumptions that underlie our IRR modeling, but basically if you want to refer to somebody else’s and tune with our thinking, I will refer you to the CFO of JPMorgan Chase, who laid out pretty explicitly what she thinks is going to happen, but I think kind of we are directionally in the same place she is, which is that the Fed will drain a lot of liquidity out of the system and that rates may rise. When rates rise, they may rise faster than people are expecting and a lot of this, I don’t know, we have laid out some modeling assumptions about how much of our non-interest bearing DDA would have – would flow out and be replaced by interest bearing funds, but it’s – and I think we are being more conservative on that front than a lot of peers and more explicit in publishing what we are modeling. So, I just refer you to that.

Geoffrey Elliott - Autonomous Research

And to the mechanism?

Doyle Arnold

As to the specific mechanisms the Fed might use and how much reliance on repos and other tools, I am not – that’s for them to decide not for me to convince.

Geoffrey Elliott - Autonomous Research

Thank you.

Operator

Our next question comes from Brian Klock with Keefe, Bruyette & Woods. Your line is open.

Brian Klock - Keefe, Bruyette & Woods

Hey, good afternoon guys.

Harris Simmons

Hello, Brian.

Brian Klock - Keefe, Bruyette & Woods

I guess, you mentioned earlier about the small business lending award in Houston, but I think knowing you guys are one of the biggest small business lenders in the country and it sounds like there has been a lot of traction there, I guess not just for you guys within the second quarter, but it still feels like that’s something that’s carrying into the third quarter. I am kind of wondering why you are being a little bit more cautious for the loan growth outlook in the third versus a good second quarter and is this anything to do with the 504 run-off? And I guess second part of that question is can you update us on where the 504 national commercial real estate portfolio balances are quarter-over-quarter?

Doyle Arnold

No. It’s not – the caution wasn’t related to any expected change in the rate of 504 run-off, that’s kind of its glide path that we have talked about. I guess it’s probably more tempering just – some of it’s tempered by the CRE limits that we are kind of enforcing for the time being until we get another read on stress testing at least and you have seen in the (EHA data), some pretty – three, three out of the last four weeks have been down for the industry for lending and we’re despite the fact that pipelines remain pretty good and small business remains pretty good. We are hearing a little caution in overall and other aspects of the portfolio. James, you want to add any other commentary on that?

James Abbott

No, I was just filling the blank on the change. The portfolio of national real-estate loans is about a little over $3 billion, about $3.07 billion. It’s divided between term commercial real-estate and owner occupied is about 60% owner occupied, 40% term commercial real-estate. The linked quarter decline on that portfolio was about $150 million. So, without that, our loan growth would have been a little bit obviously about $150 million stronger.

Brian Klock - Keefe, Bruyette & Woods

Okay. And just – this is going to probably stabilize at $2 billion, is that what your guidance has been for the glide path?

Doyle Arnold

Current production levels, we’ll put it about $1.5 billion, but we are starting to hear some green shoots. I would, it sounded this as I discussed it with the people in that group, it sounded like the green shoots of loan growth and credit quality back in 2009, you may have one or two blades of grass I think would be the description, but we are starting to hear some inquiries from community banks looking, they are starting to bump up against their liquidity ratio issues and are looking towards national real estate group as a source for that.

Brian Klock – Keefe, Bruyette & Woods

Okay. Thanks for your time guys.

Operator

Your next question comes from Kevin Barker with Compass Point. Your line is open.

Kevin Barker - Compass Point

Given when you have gone through all the CCAR process and it’s been back and forth and you have given a high level of compliance, have you ever considered rather than raising equity capital looking to spin off a bank that where you can get a higher valuation than where the stock is trading now. And that would also lower your asset size below $50 billion, so you wouldn’t have to deal with CCAR on a go forward basis, have you considered something like that rather than raising equity?

Doyle Arnold

Let me I have been answering this question a number of times Harris and I as well. I mean spinning off a bank even if we were to contemplate it – it probably doesn’t get you where you are suggesting we might want to try to be. If you got down to $40 billion to $45 billion then normal growth is going to take you back to the $50 billion mark which is cast in law currently. Within a fairly short period of time and the last thing we are going to do is blow up the capabilities that were built at great cost and great pain even assuming the Fed would say yes you have escaped, you are off the hook. I think even that point is debatable. I think you have giving – taking that path is highly, highly uncertain to achieve the outcome you are suggesting.

Kevin Barker - Compass Point

Okay. Thank you for taking my question.

James Abbott - Senior Vice President, Investor Relations and External Communications

Okay. That’s the end of the questions that we have in the end. We are over time at this point, anyway. We thank you for participating in the call today. And if you have follow-up questions please email me it’s James Abbott and I will be happy to respond. And thank you for your time and see you very soon at a conference.

Operator

Ladies and gentlemen, thank you for participating in today’s program. This concludes the program. You may all disconnect.

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