Zions Bancorp.'s CEO Discusses Q2 2011 Results - Earnings Call Transcript

Jul.18.11 | About: Zions Bancorporation (ZION)

Zions Bancorp. (NASDAQ:ZION)

Q2 2011 Earnings Call

July 18, 2011 5:30 pm ET

Executives

James Abbott - Senior Vice President of Investor Relations & External Communications

Kenneth Peterson - Chief Credit Officer and Executive Vice President

Doyle Arnold - Vice Chairman, Chief Financial Officer and Executive Vice President

David Blackford - Executive Vice President, Chairman of California Bank & Trust, Chief Executive Officer of California Bank & Trust and President of California Bank & Trust

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

Analysts

Todd Hagerman - Sterne Agee & Leach Inc.

William Stulpin - Raymond James & Associates, Inc.

Ken Zerbe - Morgan Stanley

Brian Klock - Keefe, Bruyette, & Woods, Inc.

Paul Miller - FBR Capital Markets & Co.

Jack Micenko - Susquehanna Financial Group, LLLP

Jennifer Demba - SunTrust Robinson Humphrey, Inc.

Joe Morford - RBC Capital Markets, LLC

Kenneth Usdin - Jefferies & Company, Inc.

Marty Mosby - Guggenheim Securities, LLC

Steven Alexopoulos - JP Morgan Chase & Co

Operator

Good day, ladies and gentlemen, and thank you for standing by and welcome to the Zions Bancorporation Second Quarter 2011 Earnings Call. This conference is being recorded. I would now like to turn the time over to James Abbott. Please go ahead.

James Abbott

Good evening and thank you, Huey. We welcome to this conference call to discuss our second quarter 2011 earnings.

I would like to remind you that during this call, we will be making forward-looking statements. 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.

We will be referring to several schedules in the press release during the call. If you do not yet have a copy of the release, it is available at zionsbancorporation.com. We will limit the length of this call to one hour, which will include time for you to ask questions. [Operator Instructions]

With that, I will now turn the time over to Harris Simmons, Chairman and Chief Executive Officer. Harris?

H. Simmons

Thank you very much, James, and welcome to all of you. We wish you a good evening as you join us here. We are very pleased with the continuing progress that the company is making as we return it to full strength. The last couple of quarters have been very positive for us and bode well for what the rest of the year holds in store.

Our major driver this quarter's improvement in earnings was yet another strong improvement in credit quality metrics. In fact, it was probably the most broad improvement of credit trends that we've seen cycle to date.

We experienced improvement in classified loans, in delinquencies, in nonaccrual loans, in inflows to accruals, in net charge-offs, loss severity rates, reserve coverage of problem credits and charge-off levels. So a lot of good progress continues on the credit front. We were also particularly encouraged to post a moderate increase in the loan portfolio, in balances outstanding, which we'd projected throughout the quarter at various investor conferences.

The various affiliate bank pipelines remain at healthy levels, and most of the banks expect to continue modest growth through the second half of the year. However, we're certainly cognizant of the recent softening in some of the macroeconomic indicators, which could temper loan growth. Macroeconomic trends within our footprint during the second quarter were similar to the national economy. Some of the national economy, slowed somewhat. Rental income for all the major property types improved in the majority of our markets. Cap rates continue to exhibit some of the promising trends that we've noticed during the last several months. Vacancy rates also improved across majority of our property types in our footprint. All of these factors should facilitate further problem credit resolution and improving loan growth as we go forward.

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

Doyle Arnold

Thanks, Harris. Good afternoon, everyone.

As noted in the press release, Page 1, we have posted net income applicable to common shareholders of $29 million or $0.16 per diluted common share for the quarter. As we've done previously, we also presented the earnings in a way that excludes a couple of noncash items related to the sub debt amortization and conversion into preferred stock; and the FDIC loan discount accretion, which we believe is useful to longer-term oriented investors, as we don't expect those 2 income expense items to be with us into perpetuity.

On that basis, earnings improved to $0.45 per share from $0.29 per share in the prior quarter. There are also a few small items that we can call noise that are in the numbers, but they net to a fairly immaterial number. For the rest of our agenda today, I'll highlight 4 key topics: Revenue, some additional detail on credit, capital and last, some housekeeping items for those of you trying to update your models. And in that vein, I will also then provide you with our current outlook. And then, we'll try to respond to questions.

First of all, revenue drivers. As usual, spread income accounted for 3/4 of net revenue. On Page 12 of the release, you'll note that for the first time in several quarters, there was positive loan growth amounting to $279 million or about 0.8% sequentially, which compares favorably to what the industry average reports have been on the Fed H8 data of about 0.4%.

Our growth was driven primarily by relatively strong increase of nearly $300 million in the C&I category or about 3.2%, which also compares favorably to recent industry growth reports. We also had growth in residential mortgage up about $880 million or 5% sequentially. Other color on the C&I growth, much of it is a function of existing customers drawing on existing credit lines or requesting an increase in lines of credit. Commercial loan utilization rates increased to 36% from 34.8% last quarter, and that's in spite of a 2% larger commitment balance in the denominator.

While we're seeing some erosion of underwriting standards within the industry such as only getting partial guarantees instead of full guarantees or lengthening of tenure, the most common form of competition still's on the pricing side, and we are subject to those same pressures. They're there, but they did not seem to accelerate in the second quarter per se. Most of the pressure -- the real shift came earlier this year kind of 6 to 12 months ago. And as loans mature and are renewed at the current pricing levels, we are experiencing pricing pressures on renewals.

Construction loans declined $198 million sequentially. And only a minimal amount of that decline, of about $12 million, was due to loans moving from construction into term CRE. An additional $37 million of the decline related to net charge-offs on construction loans. But that $37 million compares to nearly $100 million in the second quarter a year ago and a total of nearly $600 million in dollars of charge-offs in 2009 in construction and development loans, so. There's been very good progress over time in reducing risk in that portfolio, and loss rates continue to decline.

One housekeeping item that I'll interject for those trying to track the subcomponents of loan balances, net, we reclassified approximately $156 million this quarter of term CRE loans to owner-occupied commercial loans, which if adjusted, results in a linked quarter term CRE increase of about $21 million, very modest. That same adjustment applied to owner-occupied loans drops the growth in that category to about $19 million, also very modest. So if that wasn't clear, we'll take questions or James will take your questions and I'll answer it. But net, $156 million of what had been term CRE last quarter got moved into owner-occupied, as we reinvestigated just what those loans were.

On Page 16, the GAAP net interest margin declined 14 basis points to 3.62% compared to 3.76% in the prior quarter. That's related entirely to the larger amount of sub debt that converted second quarter compared to first. The core NIM, which excludes the amortization effects of sub debt conversion and items related to FDIC loan outperformance, was quite stable. It was 4.07% compared to 4.06% in the prior quarter, and I believe that was consistent with our guidance throughout the quarter. So the adverse effect of the sub debt conversion amortization on the NIM was 53 basis points compared with 36 in the prior quarter. And note on the rates and yields chart the discount amortization impact shows up as the cost of long-term debt, which was 22.5% this quarter, even though the coupon on that debt ranges from 5.5% to 6%.

Finally, as has been the case for a while now, our balance sheet remains asset-sensitive. Under a scenario where interest rates were to rise 200 basis points in a parallel shift and assuming approximately $6 billion of noninterest-bearing or other low-cost deposits were replaced with market rate funding, we would expect to see about a 9% increase in net interest income. Our modeling shows that we are still asset-sensitive, but less so in various nonparallel shifts in the curve.

Shifting to credit, on Page 13 as Harris mentioned earlier in the call, virtually all of the major credit quality metrics improved when compared to the prior quarter. We had a couple of highlights that aren't not in the tables on Page 13 through 15 of the release.

First, inflows of new nonaccrual loans again declined. They were down 22% from the prior quarter to $263 million. Loss severity as measured by loss experienced in classified loans, or loss given classified status, continue to trend moderately lower for the portfolio overall. C&I loss severity improved the most for the second quarter in a row with owner-occupied following close behind.

The performance of classified and nonaccrual construction loans was quite strong this quarter. Classified residential construction loans declined 39% from the prior quarter, and nonaccrual residential construction loans fell 26%. Classified commercial construction loans declined 19%, and nonaccrual commercial construction loans declined 13%. Additionally, classified term CRE loans declined 12%, a strong improvement compared to the prior quarter's modest decline of only 2%.

The allowance for credit losses, which includes both the ALLL and the reserve for unfunded commitments, declined to $1.34 billion from $1.45 billion last quarter. Nevertheless, all of the coverage ratios strengthened relative to problem credits and loan losses. And in fact if you annualized the second quarter net charge-offs, the reserve now covers nearly about 3 years of charge-offs.

Quantitative factors declined significantly due to the aforementioned trend, namely, the reduction in both classified loans and the continued improvement in loss rates on classified loans. However, we increased the qualitative component of our loan loss reserve by about $35 million due to some of the clouds that formed on the horizon, namely things like European debt situation uncertainty over U.S. fiscal policy and a number of disappointing economic reports and forecast revisions during the quarter.

Let me touch briefly on troubled debt restructurings. As you know, there's new reporting guidance that comes into effect for the third quarter. We're currently reviewing all loans within the portfolio to see which ones may meet the new FASB guidelines for a TDR that weren't reported previously. We are not -- we have not completed that review, but we do expect a modest increase in TDRs as a result of the more broad criteria for whether a loan was renewed or restructured at a market rate, whether the loan was troubled, which was broadened to include the loans likely to become troubled within the foreseeable future. Again, though, we think that increase will be modest. And any increase in the TDRs will have no impact on our net charge-offs, the allowance for loan losses or provision expense. Thus, while change in accounting may be helpful to some, it will not fundamentally alter how we run the business or our outlook for profitability and earnings growth.

Shifting now to capital. The tangible common equity ratio declined 6 basis points to 6.95%, entirely driven by the increase in deposit balances of nearly $600 million. Those are primarily noninterest bearing deposits, and this led to a nearly similar-sized increase in assets, with a majority of the increase going into cash and cash equivalents.

Another headwind of the TCE ratio is the sub debt conversion, wherein tangible common equity balances were reduced through the conversion process. And that direct impact on common just about offset, not quite, but largely offset the net earnings to common during the quarter. Tangible common equity relative to risk-weighted assets was steady in the prior quarter or compared to prior quarter. Tier 1 common ratio was unchanged at 9.32%. Other reg cap ratios were stable through very modestly stronger compared to prior quarters.

With regard to the bank trust preferred CDO portfolio and as it relates to capital, you'll notice on Page 5 of the release 2 changes in the carrying values of all 3 classification buckets. This was driven largely by an increase in trading volume in the markets for these securities, but also by a sale of some of the CDOs. First as trades occur, and in no way would we have classified the market as liquid, we nonetheless consider the pricing of such trades if they're non-distressed relative to our portfolio marks. This has been our practice for several quarters now. And last quarter, you may recall that there were more trades in the original AAA-rated securities, which caused us to reduce their carrying value last quarter. Additional trading in the original AAA-rated securities in the second quarter actually drove an increase in their value, taking that group up to 65% of par from 59% last quarter, more or less reversed the decline that we posted last quarter.

However, we observed this quarter a few non-distressed trades in the original A and BBB-rated securities that were somewhat comparable to ours. Consideration of these trading prices and valuation process led us to reduce our estimates of fair value for these junior tranches. In addition, we took advantage of the slight increase in liquidity to sell a handful of CDOs for a net loss of $4 million, or about 4% haircut to our amortized costs on those securities. This had the primary benefit of reducing classified assets, and it reduced the par value of our TruP CDOs by $185 million and amortized costs by $95 million, as noted in the text of the press release.

I know many of you will have questions about the timing of TARP repayment, and let me address those in advance by saying I'm not going to address them. We note that we've achieved some important milestones or are well on the way of achieving them, as we've discussed previously. These include return to profitability, dramatically better credit quality ratios, stronger capital levels and enhanced operating practices. Beyond that, I'm simply going to refer you to previous guidance and we're not going to talk about TARP repayment. At that time when I said sometime in the second half of the year, we'd be sitting down with the Fed. I still think that's the case, and I would rather negotiate with them, not with you folks on the line, and not negotiate with them through comments in public. So that's about all there is to say about that.

Now a few other housekeeping items, noninterest income. Dividends and other investment income, you may have noticed jumped considerably. This was in part due to the reevaluation of an interest and in an equity investment. Well, we think the quarterly run rate on this item may be more or less $10 million in the near term, but again it will probably be somewhat volatile. But just to caution, you shouldn't extrapolate this quarter's revenue from that line into the future, maybe build off of something like $10 million in your model.

As a reminder, we do expect to incur a quarterly expense of $5.3 million for the total return swap on the CDOs this quarter. That has not been in the last three quarters, as you may recall. It will show up as a contra item within the fair value of non-hedge derivative income line.

Moving to noninterest expense. Salaries and benefits jumped by about $7 million, primarily due to bonus accruals. That's a function of recent better performance, absolutely and relative to budget. There's also about $4 million of expense that's more akin to onetime or temporary items that you probably would be advised not to annualize and grow.

Regarding FDIC premiums, the new formulas for computing premiums became effective this quarter. And as you note, that line item was about $15 million compared to about $25 million in each of the last several quarters. $15 million, we think, is the starting point for the run rate going forward. And the amount may decline somewhat over time, as some of our credit quality metrics and other things that drive the rather more complex calculation improve. Although if there's any asset growth, that may somewhat offset that, but let's see.

Our provision for unfunded lending commitments was negative $2 million compared to a negative $10 million in the prior quarter. Second quarter is more typical of the level we'd expect to see, assuming continued credit improvement and moderate growth in loan commitments. Credit improvement will improve it, loan growth will increase it. And so maybe somewhere around 0 should be your starting point for the near term.

Okay, more broad guidance for the next few quarters. Regarding the balance sheet, we expect the overall balance sheet size will remain about flat through 2011, or possibly grow modestly. If there's growth, it will be driven, as it was this quarter, by cash equivalent asset increases that result from deposit growth. As a base case, we expect the loan portfolio to continue to show flat to very modest growth over the medium term. Pipelines are healthy. Production volume increased somewhat in the past few months. But there's more uncertainty today compared to 3 months ago with regard to the impact of economic news. And in fact, loan balances were flat in the month of June and are more or less flat here in early July. So I wouldn't take the change from first quarter's decline in loans to this quarter's growth in loans and just build that delta in. I think it's going to be more modest than that.

With regard to the margin, we think the core NIM will remain generally stable during the next several quarters as it has been for the last several. Some modest pressure may arise if deposit growth continues at recent rates simply due to high ratio of incremental cash growth at very low yields compared to incremental loan growth. If loan growth does exceed deposit growth, we fully expect NIM expansion.

With regard to credit quality, notwithstanding the weaker economic news, we still expect charge-offs to continue to decline over the next couple of quarters. We expect nonaccrual loans and other adversely graded loans will continue to recede at a healthy pace. This is likely to result in very low provision expense in the second half of the year. But we will watch closely the economic environment and leading indicator developments, which may continue to pressure upward our qualitative adjustments to the reserve.

Tax rate, we would expect the rate to be between around 38% and 40% for the full year, which implies about a 36% rate for the second half of 2011. This assumes moderate amounts of sub debt conversion. If a large amount occurs, it would have the effect of raising the effective tax rate.

Regarding sub debt conversions, we expect to file an 8-K in mid-August regarding sub debt conversion amount for the third quarter. That's when we will know the amount that has been posted for conversion by the owners of the debt. It's difficult to predict the conversion amount in advance, as you know. However, we would note that the outstanding balance that can convert this quarter is only $247 million, roughly half the dollar amount that was able to convert in the second quarter. As the conversion amounts in the first and third quarters tend to be lower. And all else being equal, we would expect this one to be lower as well. I'd also note that the ARB spread, i.e., the pop that one could get from converting sub debt, if you marked it up to market to preferred, has been very low of late. In some cases, it's even been negative. And thus, one of the major incentives to convert has moderated substantially.

With that, I think we will give you a couple of minutes to queue up questions. And moderator, we'll turn it back to you.

Question-and-Answer Session

Operator

[Operator Instructions] Our first questioner in queue is Ken Zerbe with Morgan Stanley.

Ken Zerbe - Morgan Stanley

Regarding your TruPS CDO portfolio, I know you said the market is far from liquid. But obviously you are able to sell some into the market now. Can you just address your willingness or appetite to continue to sell the TruP CDOs as I guess the market permits?

Doyle Arnold

Very hard to predict. I think where we can -- clearly those are perceived and maybe actual source of risk on the balance sheet. And I think it's safe to say that we would -- we're continuing to look for opportunities to reduce risk on the balance sheet where it can be done at reasonable cost. So this is something we'll continue to look at. But I don't have a target amount or even a guidance amount. But it is something that we will continue to look at.

Ken Zerbe - Morgan Stanley

I know it's hard to answer. The other question I had just in terms of the core NIM. Your guidance is stable for the next several quarters. Can you just talk about the drivers of how you get there? Obviously, your comments about competition such in C&I pricing that remains challenging, and that you're seeing some asset yield compression. Do you have enough deposit room? Or is there -- to reduce your deposit costs or are there other factors that we may consider in terms of how you get to stable core NIM?

H. Simmons

I think that the -- what was Chairman Mao's phrase, the correlation of forces, remains much as it has been in the prior quarters. If we have -- obviously, a buildup in cash balances is a depressing effect. Any loan growth is a positive effect. The decline in nonperforming assets is a positive effect. There's -- if you noticed, I think the decline in interest, in deposit cost of 4 basis points and the decline in loan yields of 4 basis points exactly offset each other this quarter. So we would expect that to be probably a continuation of that very small amount or change on both sides of the balance sheet in the next quarter or 2. James, you want to add anything to that or any major thing?

James Abbott

On core NIM, obviously, I think implicit in my remarks is the fact that we would expect the reported NIM to be quite a bit higher this quarter.

H. Simmons

I'll just jump in and say I think the pricing pressure we're seeing tends to be -- I don't think it's really across the board. It tends to be on larger, very high-quality kinds of deals. And so we're not seeing that kind of pricing stress uniformly. And It's clearly there on larger deals, less so on kind of small middle market credits.

James Abbott

This is James. I'll just interject that in terms of pricing, loan pricing on owner-occupied which is a core business for us of course, loan yield was about 5.6% on a incremental production basis. So we're still getting very, very healthy yields on a lot of the production. But in the larger corporate deals, to Harris' point, there is more pricing pressure there than in other areas. Although if you talk to lenders, they'll tell you that there's still pricing pressure even on the smallest deals.

Operator

Our next questioner in queue is Todd Hagerman with Sterne Agee.

Todd Hagerman - Sterne Agee & Leach Inc.

Just want to follow up on your comments on the loan growth. You mentioned that a good portion of the growth this quarter came through existing customers. I'm just curious as I look at the 1- to 4-family portfolio, the energy portfolio and the SBAs within C&I, was there anything in the way of purchased loans that may have influenced the balances to any degree this quarter?

Doyle Arnold

Well, I think the comment about existing customers was primarily targeted at C&I. I believe that's what I was referencing there. Clearly some of the home mortgages were new, et cetera. There were no major loan purchases. There were included in the C&I growth was on syndication or participations, but no portfolio purchases, would that be a fair way to describe it? Did I address your question?

Todd Hagerman - Sterne Agee & Leach Inc.

Yes, that's very helpful. And just as a follow-up to that, I'm just curious given kind of the sluggishness in the economy and demand, for all intents and purposes remains fairly weak if you will, is the company in a position in terms of thinking about, perhaps alternative kind of asset purchases, other loan purchases to help improve the yield, or are you saying those kinds of transactions or deals being presented at this time?

Doyle Arnold

We do occasionally see distressed portfolios that we have looked at. we, by and large, decided to focus on further reductions in our own level of classified and other weaker quality assets. So we've not really gone there except in very one-off cases. And no, we're not considering any bulk purchases of other portfolios. We've seen a few here and there, but we're pretty determined to stick to customer relationship lending within our territory. And the portfolios that I've seen tend to be portfolios of leases that are nationwide or some other things that are nationwide where there's no relationship with a big chunk of the portfolio. And that's not the direction we're headed.

Todd Hagerman - Sterne Agee & Leach Inc.

And that's consistent within the energy portfolio as well, correct?

H. Simmons

Yes.

Doyle Arnold

Yes. Is there a question behind that question?

Todd Hagerman - Sterne Agee & Leach Inc.

No, again just with the improving demand and again just kind of the Amegy's kind of historical lead role within those relationships that, given kind of the drivers within the energy sector and some of the volatility we've seen, whether or not there are other opportunities that have presented themselves outside of kind of your existing customer relationships.

Doyle Arnold

No, I mean, that's some of the -- when I mentioned syndications and participations, a lot of that would be at Amegy and it would -- a lot of that would be energy-related in one way or another. But it's not -- again it's not portfolio kinds of purchases and that's not something we're considering.

H. Simmons

In any case, we're selling pieces off. I mean, we're auctioning. So it's works both ways. But I think it's very consistent with what we've been before. And I'll also just say this point in the cycle, we're not getting antsy to go out and do anything particularly aggressive.

Operator

Our next questioner in queue is Ken Usdin with Jefferies.

Kenneth Usdin - Jefferies & Company, Inc.

Doyle, I was just wondering if you can just expand upon at this point in the cycle, you're starting to see loan growth get a little bit better, and yet deposits are still really coming indoor at a great pace. Can you characterize where the deposits are coming from, new customers, existing customers, different parts of business? And what you expect to happen over time? Do you expect to see deposits get drawn as credit comes back? Because it still seems that we're just getting both. You're getting great amount of deposits and yet the loan growth is starting to come back.

Doyle Arnold

Well, the biggest amount of deposit growth remains in commercial noninterest-bearing transaction accounts, commercial checking accounts, as it has been for many, many quarters now. And there are -- as you know, treasury management is something that we have placed great emphasis on for a number of years now. So we do continue to add customers and shows up in increased customer accounts in those kinds of categories. But I think it's fair to say that the bulk of the increase in balances from existing customers who are just piling up more and more cash, it's very much related to the fact that I think there's no other investment alternative that reasonably safe where they can earn anything. They are -- the profitability has improved among a number of our customers. So they are generating cash and they appear to be reluctant to deploy it in the continued economic and policy uncertainty that's out there, probably things you've been reading about and hearing about from others. We are seeing a few businesses. I mean as well, we have seen better growth in C&I. We've also seen a smaller decline in -- I mean, some of the net growth is the fact that we've reduced the construction and development portfolio from a peak of, I think, over $8 billion 3.5 years ago to about $2.7 billion today. And you're beginning to get to a point where that's a little bit more of a steady state, with, in fact, I think our best guess is it's probably what's left, 2/3 of it, has been originated post-crisis in this new production, new projects that are in construction today. So I don't -- things are better. There's not doubt about it, but they don't feel like they're accelerating right now.

Kenneth Usdin - Jefferies & Company, Inc.

My second question is can you walk us through in the circumstance that Deutsche Bank were to be downgraded, given what's going on across the pond would there be any ramification on the swaps? And how would that work, if so?

Doyle Arnold

Well, we now have the right to renew or cancel the swap every quarter from here on out. We prepay the first year's worth and that was that. So it's $5.3 million roughly of pretax expense every quarter. And if for any reason we decide that Deutsche Bank's rating is not worth keeping them behind the total return swap, we can cancel it. The impact of canceling it would be roughly about a $4 billion increase in risk-weighted assets, which would be about a 10% increase in risk-weighted assets or I think a little over $40 billion. So you can kind of apply that to regulatory capital ratios, and they would adjust accordingly. David, you want to...

David Blackford

My only other comment would be we also -- and there are triggers, I won't go into details. But within the agreement, there are triggers wherein they would have to pledge collateral if they got downgraded to protect us if in fact that would happen. Those are the 2 issues, the one Doyle just talked about, the fact that we have the right to claim collateral under certain conditions.

Operator

Our next questioner in queue is Marty Mosby with Guggenheim Partners.

Marty Mosby - Guggenheim Securities, LLC

I wanted to comment just go through the kind of core earnings exercise. But if we looked at the reported $0.16 and we adjust for the debt conversion, we're right around $0.50 per quarter now. We have Durbin coming up and swap expense coming online. But we got some loan growth and deposit growth. Hopefully that kind of hold that $0.50 in line. If we look at credit-related expenses, right about $35 million worth of foreclosure OREO kind of expenses that were on the income statement, how fast can we see some of those starting to move down?

Doyle Arnold

I think they've already moved down a bit, and we would expect them to continue to trend down. I don't have a forecast to give you. But there are -- most of those -- I think those 3 different lines that we break out for you on the income statement, the other real estate, the credit-related and the unfunded commitments. So I've already told you the unfunded commitments probably average around 0 to the loan portfolio growth becomes slightly positive. But it could be slightly negative for a while, i.e. a negative contra expense if credit quality continues to improve, which we think it will. OREO is, I mean, gosh, look at it. It's come down from $40 million to $45 million down to $120 million. I think that the general trends should be that it continues to come down, but I don't have a read on the pace. And maybe the other one that's a little bit stuck is the other credit-related expense. But even that, which is appraisals and other things like that, that should begin to decline as we get further down into the pile. You got anything else you want to say, Ken or James?

Kenneth Peterson

I would just add, Marty, that historically when property prices are rising 20% so take this with a grain of salt, but that other credit-related expense line item was about $2 million per quarter. So we probably won't go back to that level, but you could see it down into the single digits at some point down the line.

Marty Mosby - Guggenheim Securities, LLC

And this is the first quarter that we really had a provision number close to 0, which would obviously be less than we would think. So we're getting a benefit from that. Kind of compare that to our kind of normal of $60 million per quarter, just as a rule of thumb. Maybe we're adding $0.20 into our number this quarter. Whereas, Doyle, when you mentioned the asset sensitivity, if you kind of run that through the numbers, you kind of offset that with a potential margin improvement once we get the rate rise. So the timing of the usually lower provision being matched with hopefully rates going up at some point, kind of how do you see those two things because in size they kind of match up with each other?

Doyle Arnold

Timing is everything as someone once said. The other thing I'll point out to you is that our cost of capital is rather high. The reported cost of sub debt is rather high. Once the sub debt conversions taper off, and I do think that's likely to happen, the cost of the remaining sub debt will begin to drop significantly back to just more normal amortization level. The coupon is 5.5% to 6%. We basically mark it to market at around $0.50 on the dollar. So the normal amortization would take that up to around 11% or 12%, but it's 22% this quarter because of conversions. Knock it down to 11% or 12%, you got a drag there. TARP dividends are $70 million after-tax annually.

H. Simmons

That's the cash expense.

Doyle Arnold

That's the cash expense. And there's a little bit of amortization of the, I guess, the equity component of it. And when you got some expense in preferred, that becomes callable middle of next year. So there, you can't just look at the expense items. You got to look at the capital and funding structure as well.

Operator

Our next questioner in queue is Joe Morford with RBC Capital Markets.

Joe Morford - RBC Capital Markets, LLC

Just wondered if you could talk a bit more about the type of growth you're seeing in Amegy's energy portfolio and the type of pricing or spreads you're getting on that, and kind of what expectation you have for the portfolio going forward.

H. Simmons

Well, it's been -- it hasn't been solely in energy. It reflects the fact the Texas economy is simply adding more jobs than any place else in the country. But certainly, a slug of it is energy-related as we've seen additional activity there. It's been both production, some service-related credits. Pricing has -- and this is just sort of anecdotal for me is I've looked at deals. Pricing is maybe a little tighter than it had been kind of a year ago. But we're still seeing reasonable pricing on the kinds of credits we're doing. I think we're also seeing, in selected areas, quality real estate opportunities, fully leased or almost fully leased office building. We have a construction loan there with a heavy credit tenant. And we're also seeing a little bit across the board in C&I. So the general Texas economy is resulting in opportunities and energy a little bit in real estate and C&I.

Doyle Arnold

For the person taking the transcript, that was Ken Peterson, our Chief Credit Officer speaking last there.

Joe Morford - RBC Capital Markets, LLC

And I guess my follow-up would just be any other comments about any of the other regions and some of the growth trends you're seeing or lack of growth. And also you'd talked in past or this quarter, you were expecting to see less in the way of CRE paydowns into that play out.

H. Simmons

I just note, we said 6, 9 months ago that we were likely to see some increased focus on 1- to 4-family residential here, and you see some of that in our numbers. We simply think that there's been some opportunities there with prices having come off and a lot of other lenders who've had heavier doses of that, probably less aggressive than they've been in some other product categories. So we've added there, incrementally, I'd say just about economies in some of the states, I mean, the Utah economy, because this is still large part of our business in Utah, Idaho. The economy here continues to improve. The unemployment rate is now down. I think it's roughly 7%. We're seeing reasonable job growth here. And a lot of -- we have seen a lot of corporate location announcements. I think the sort of the sentiment here is reasonably, this is pretty positive about what the next 2 or 3 years might hold in terms of growth in the Utah economy. California, probably, we all read about California. There are challenges there, and probably will be for the next 2 or 3, 4 years. Talked about Texas. Arizona, Nevada, they're going to be slow for a while. And we are seeing some commercial loan growth in Arizona and we're going to focus on that. We're seeing some, some -- and their volumes have been recently stable for the last year as a result, in part, of a little better commercial loan growth there. So kind of spotty. Texas really has been best driver of loan growth. Utah is looking like it could kind of chip in, in the second half. Other places still probably kind of...

Doyle Arnold

I think, the other comment, I think is that I don't think there's any place in the company where we're continuing to see just dramatic declines at this point. The worst case is about flat.

H. Simmons

Flat in Nevada.

Doyle Arnold

In Nevada, maybe still a little bit of decline there, particularly outside the residential 1- to 4-families that they've done there in the last couple of quarters. At the other end of the spectrum, Texas, as Harris said, has the strongest economy followed by the intermountain west.

Operator

Our next questioner in queue is Chris Stulpin with Raymond James.

William Stulpin - Raymond James & Associates, Inc.

Within loans, do you have a runoff amount for this quarter and the last quarter as well? I'm trying to see if any kind of trends are developing there as far as runoff within your loan portfolio?

Doyle Arnold

What do you mean by runoff, please? You mean the...

William Stulpin - Raymond James & Associates, Inc.

I guess last quarter's balance, maybe when you add in production then you see where this quarter came out. I'm basically trying to see what the difference is.

Doyle Arnold

Broadly speaking, most of the loan officers that we've -- that I talked to have suggested that there has not been an increase in the prepayment speed. The production volume for the quarter was a few hundred million higher, about $400 million or so higher than it was last quarter and you saw the loan growth. So that also would be another way of triangulating the fact that prepayment speeds haven't changed a lot. if you look at or you can't, we have our internal portfolios to talk about. Look at the PPR speed of various different assets, and those did not change at all really compared to the prior quarters. Not much change in payoffs, paydown rates, but a little bit -- it's about actually about a 20% increase in production volume this quarter compared to the prior quarter.

Operator

Our next questioner in queue is Steven Alexopoulos with JPMorgan.

Steven Alexopoulos - JP Morgan Chase & Co

Maybe first on the loan growth, Doyle. Could you break out the dollar amount of loan growth that came from the energy book in the second quarter? And then maybe talk about the types of mortgages that you held that drove the 1- to 4-family. Are these fixed-rate mortgages?

Doyle Arnold

James is looking up the first part. I'll start on the second part of your question. The mortgage growth came in California, Texas, Colorado. And I think the fourth state was ...

Kenneth Peterson

It was Nevada.

Doyle Arnold

It was Nevada, yes. And none of it's, with the exception a little bit of Nevada, it's all variable rate. In California, it's jumbos. We're finding good opportunities for relationship lending there. I mean in general, we've just found the pricing to be acceptable and the relationship opportunity's good. There are just so much carnage in that market, and so many -- the bigger players are distracted by problems that we found ways to do a little bit of good.

Kenneth Peterson

They tend to be 5/1 ARMs, 7/1 ARMs.

Doyle Arnold

That's the bulk of it.

Kenneth Peterson

Some kind of shorter-term fixed rate for amortizing kinds of deals.

Doyle Arnold

You have a comment on energy, James?

James Abbott

Energy portfolio at Amegy anyway was up about $100 million linked quarter from about $1.6 billion to about $1.7 billion outstanding.

H. Simmons

Let's see how that compares to the prior quarter, I think.

James Abbott

Well, the prior quarter's $1.6 billion in total.

Doyle Arnold

But the growth, is it accelerating?

James Abbott

Oh, I have to catch with that.

Steven Alexopoulos - JP Morgan Chase & Co

Maybe just as a follow-up on the margin because you're guiding to a stable core NIM. But with the cost of interest-bearing deposits at 51, how much lower can that realistically go? And should we assume that you assume no negative impact from the reappeal of Reg Q?

Doyle Arnold

Well, it's been coming -- the cost of interest-bearing deposits has continued to drift down 3, 4 basis points a quarter. And part of that is just the fact that some of the growth is not in CDs, but it's in very low cost savings accounts where we're paying 5, 10 basis points, what have you. So I do think there's probably room for a little continued drift down. We're not going to be -- I think it's fair to say we're not big enough to be the market leader on whatever happens on Reg Q. So I don't have a firm hand on what that might be. It's hard to understand why there'd be pressure, given that the whole industry is awash in liquidity to move aggressively on pricing if deposits in this environment don't.

Operator

Our next questioner in queue is Brian Klock with KBW.

Brian Klock - Keefe, Bruyette, & Woods, Inc.

Just thinking about the loan growth of the loan pipeline. You guys are one of the biggest small business lenders in the country. So I would think that some of the margin pressures that others have been talking about you guys may be insulated from. And I guess that I'm kind of wondering how that small business loan pipeline looks for you guys as you head into the second half of the year.

Doyle Arnold

Insulation comes at a variety of R ratings. I'm sure we're at R32, but there is less pricing pressure when you get down and where the, as Harris said, the largest high-quality corporate credits.

H. Simmons

I think it's fair to say in terms of just the pipeline there, it is still -- that's still kind of slow. I mean, we're not seeing a big surge in small business credit demand that qualifies. I mean, the last numbers I've seen here, really it's not getting worse, maybe firming up a little bit. But I don't think that's going to be a source of a lot of growth in the next 3 to 6 months.

James Abbott

Yes, I think most of the indicators, both the national indicators as well as some of the local ones that are done, suggest that small businesses are still struggling. One of the comments from a lender, actually it was a group call that I had very recently with a bunch of other lenders. And they said the small business owner is a lot of times relies on their personal equity to expand the business to some degree. And those equity levels have taken a hit, And so they are still rebuilding themselves. So we're not seeing a tremendous amount of growth out of that. But their commentation -- that's probably not the word. But their comments are that they are feeling much more comfortable about the credit quality of the small business portfolios at this point because balance sheets have healed.

Brian Klock - Keefe, Bruyette, & Woods, Inc.

Your credit quality is still -- the trends are continuing to improve nicely. Your classified loans are down almost 50% year-over-year. Maybe I guess, I know that you guys kind of guided, Doyle, to provisions being low in the second half of the year. I mean, I guess is there kind of way to gauge whether or not is that something that's going to be $10 million, $20 million, $30 million? I mean, should we expect another 2 quarters of $1 million provision, or maybe just give us some kind of -- what does your crystal ball say is a more realistic level or normalized level, if you will, of provision?

Doyle Arnold

Well, what's your crystal ball say is the economic unemployment rate and what not in the -- It's hard to say. Again, I'd say -- I kind of made a comment about the economy only somewhat facetiously because as I noted, we did increase the amount of reserves, that it was driven purely qualitatively by the deteriorating economic outlook as opposed to what we can see in our portfolio based on the historic metrics. Had we not done that, we would have had a negative provision of $35 million, $50 million this quarter. So it's going to be low. I'm not trying to telegraph a negative provision. But I would guess next quarter, it's going to be somewhere around 0, but there could be plus or minus several tens of millions of dollars around that.

Operator

Our next questioner in queue is Jennifer Demba with SunTrust Robinson

Jennifer Demba - SunTrust Robinson Humphrey, Inc.

Can you just give us a sense of how much Zion is participating in loan syndications today maybe versus 6 months or 1 year, 1.5 years ago? Can you just talk about that activity?

James Abbott

Jennifer, this is James. There's really been no change in terms of a ratio. From a percentage perspective, it's about 7.3% of the portfolio today, when you add up all of the balances of loans purchased and all of the balances of loans where we act as the agent. September of '09 is as far back as my page goes for now, but it was 7.9% back then; and a year ago, it was 7.1%. So it really hasn't changed a whole lot. But on a net basis, we actually had -- it's really been very, very stable there.

Jennifer Demba - SunTrust Robinson Humphrey, Inc.

Are you seeing fewer phone calls from larger banks as they maybe increased their hold limits?

Kenneth Peterson

Well, I think what we have seen is -- this is Ken Peterson. What we have seen is the larger banks weeding out numbers of their participants and asking for larger positions in the stronger credits with the remaining banks. So while the net may not have changed that much, I think some of the agents are trying to clean up the number of banks they have in any given syndication.

Operator

Our next questioner in queue is Jack Micenko with FIG.

Jack Micenko - Susquehanna Financial Group, LLLP

I guess maybe another way to ask it, not just maybe the next quarter but over the next 4, 5 quarters, Doyle, you talked about obviously the qualitative pieces that have been coming up with regards to loan growth. Do think, if you thought or talked about sort of the right size or the reserve-to-loan ratio, can we can think of it maybe that way, and maybe we're...

Doyle Arnold

No, we can't. You know as well as I do, the regulators, I mean, they've been very straightforward. I was just reading before this call the new Basel III update from I don't know, a few weeks ago. And they're very open and transparent that they want an expected loss model like IASB, whatever it is has proposed, that they want the reserve to be more countercyclical. But that's not U.S. GAAP today, and we're caught on the horns of that dilemma as well. But we probably like to see that less volatility in that number as well. And I think it's fair to say that the reserves kind of never again get down to the 1% range that it once was one way or another. But where it will settle out in the very best of times, I wouldn't want to forecast.

Jack Micenko - Susquehanna Financial Group, LLLP

And then just a follow-up with rates coming down on some of the jumbo product that you did note you are doing in some of the more distressed markets, has your appetite changed over the last 3 months in putting them up on the balance sheet? Or has the 3, 5, 7 kind of paper held up better on the spread side of the jumbo product?

Doyle Arnold

Well, a distressed market doesn't mean distressed borrower, let's be clear on that.

Jack Micenko - Susquehanna Financial Group, LLLP

Right, right, right.

Doyle Arnold

We're not bending our lending standards to put on new product in California, say. And I assume that's what you're talking about since I wouldn't characterize Texas and Colorado as being distressed markets. We just -- there's just not a lot of people active in the nonconforming jumbo space. And so we're finding good opportunities in California to put on that kind of product. And yes, it's mostly 5 and 7/1 ARM and it's prime product.

James Abbott

We'd continue -- as some of the other portfolios have flattened out in the month of June. Residential mortgage grew, but at a very, very slight rate during the month. So it continues to grow a little bit in a couple of July here so. But I would emphasize that it's very slight.

Operator

Final question comes from Paul Miller with FBR Capital Markets.

Paul Miller - FBR Capital Markets & Co.

Most of my questions have been answered, but I do have a question about the deposits. If we're not really seeing a lot of loan growth, I mean, why continued growing loan deposits? Why not lower your deposits? A couple of guys have brought this up, but why not push those deposits out the door because you really don't need them?

Doyle Arnold

How do you propose that we push deposits out the door when the growth is primarily balances in DDA accounts for current customers? I don't really want to tell the customers to get the heck out of dodge.

H. Simmons

I mean, we're trying to do that with pricing, clearly, but we're also really trying to manage the place for the long term. And 3 years ago, you would have killed for liquidity. We expect 3 years from now, we might be in the same position again. So the focus is really on making sure that we're holding on to what we view as long-term, core profitable relationship accounts. And sometimes you have to be competitive to hold on to those kinds of accounts. But you want to be in longer-term what you're thinking about it right now. Just in the same way that you could go out and put on a lot of securities, for example, that opportunistically might look great right now, then they look awful years from now. And so we're really trying to think about what does the place look like in terms of years from now.

Doyle Arnold

It's a difficult -- it's a high-class, but difficult problem because it is painful in the short term. We certainly acknowledge that. But as Harris said, we are managing towards the belief that this current set of conditions will not continue indefinitely.

Kenneth Peterson

I'll just comment that you need to remember that the unlimited insurance and checking accounts goes away on January 1, 2013. We're not making forecasts here, but I strongly believe that in January 1, 2013 when this insurance goes away, we won't have $14.4 billion of noninterest-bearing checking accounts.

James Abbott

That will have to be our last question for today. We've jot down the names of those left in the queue, and I will do the best I can to get back to you tonight. It may be late, but I will make the effort. Thank you again all for your time and your work today to look at our company, and we appreciate it. We will be in touch with you shortly.

Operator

Thank you. Ladies and gentlemen this does conclude today's program. Thank you for your participation and have a wonderful day. Attendees, you may log off at this time.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!