Zions Bancorporation (ZION)
February 16, 2012 10:30 am ET
James R. Abbott - Senior Vice President of Investor Relations & External Communications
H. Simmons -
Doyle L. Arnold - Vice Chairman, Chief Financial Officer and Executive Vice President
Unknown Executive -
Kenneth E. Peterson - Chief Credit Officer and Executive Vice President
W. David Hemingway - Chief Investment Officer and Executive Vice President of Capital Markets & Investments
Aldon Scott Anderson - Executive Vice President, Executive Vice President of Utah & Idaho Administration, Chief Executive Officer of Zions First National Bank and President of Zions First National Bank
Scott J. McLean - Chief Executive Officer, Director and Member of Executive Committee
Steve D. Stephens - President
David E. Blackford - Executive Vice President, Chairman of California Bank & Trust, Chief Executive Officer of California Bank & Trust and President of California Bank & Trust
Bruce Alexander - Chief Executive Officer and President
Keith D. Maio - Chief Executive Officer, President and Director
Erik Oja - S&P Equity Research
Jennifer H. Demba - SunTrust Robinson Humphrey, Inc., Research Division
Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division
James R. Abbott
We are grateful to have all of you here today for Zions 2012 Biennial Investor Day. We have quite an agenda for you today. Those of you who are here in person has all of the -- has the book. If you are not here participating in person but are doing this by the webcast, there should be a PowerPoint presentation available on our website, zionsbancorporation.com. If for some reason you're unable to find it that way, please feel free to e-mail me at email@example.com and I will e-mail it to you during the day.
We're, again, appreciative of the opportunity to have all of you here today and we think we have a pretty good presentation, a pretty good story to tell. We'll start off with our Chairman and CEO, Harris Simmons, who will give an overview of the company and some of the big picture trend. We move to -- after that, we move to a presentation on earnings and capital by our Vice Chairman and CFO, Doyle Arnold. And at that point, we'll take a break and introduce the rest of the program. With that, Harris, I'll turn the mic over to you.
Well, thanks, so much for being here with us today. [indiscernible] this projector on your right and we'll try and get that fixed during the break. So there's a -- well, on this side of the room, you can see the slides a litter better. But I -- you all have the slides and so I presume that you could follow along. We're also delighted a lot of you are going to be joining us, some of us skiing tomorrow, we look forward to that. It should be a great day.
This has obviously been a really crazy time the last few years in the industry. Some people will check this when I ask them the name, Zions Bancorporation there's some kind of religious thing going on with the company and the answer's no. But I did get a phone call from about 3 years ago, a banker whose bank we'd acquired from Central Arizona. Elton Baltimore [ph] called me up about 3 years ago. He said he's been in some Bible study and that morning he was thinking of us because they were setting the 126 Psalm in the New Standard Version of the Bible and it goes like this, it's called The Song of Ascent, I think that means higher stock price. It goes: when the Lord restored the fortunes of Zion, we were like those who dreamed. When our mouth was filled with laughter and our tongues with shouts of joy. It was said among the nations, the Lord has done great things for them. The Lord has done great things for us and we rejoiced. So I thought that was maybe a good omen. My own favorite Psalm was actually the 37th Psalm verse 21. It reads, the wicked borroweth and payeth not again but the righteous show us mercy and giveth. Well, we occasionally find use for the Bible in our business here.
I actually particularly like as I think about what this industry has been through, something that the comedian Conan O'Brien said. He said that, quoting Nietzsche who famously said "Whatever doesn't kill you, makes you stronger." He said that what he should have said is whatever doesn't kill you makes you watch a lot of Cartoon Network and drink lip-priced [ph] Chardonnay at 11:00 in the morning. It's been a tough time in the industry but I think that we're all emerging stronger for it and it doesn't kill us and it's still here and getting stronger every quarter.
We're going to -- I'm going to tell you what we're going to tell you and then we're going to have people to tell you and then we're going to tell you what we told you today. And I really hope that it sinks in. The -- I think the fundamental messages that we want to -- we hope that we can get them into our -- the core franchise of this company is, in fact, been stronger than it's ever been. Our capital levels are very strong. The credit trends continue to improve. Charge-offs are below industry levels. We've actually come through that in quite good shape relative to a lot of our peers. That the core risk tariffs have been significantly reduced and particularly in our -- as part of our portfolio, this did the most damage. We've essentially de-risked that and I can tell you this that isn't -- we'll never find ourselves at that level of construction development exposure again.
That we've put in place a lot of the controls and new processes. We come through a cycle like this and certainly try to learn from it and we have and tried to establish some new procedures and things that will be helpful, we've experimentally [ph] been stronger. And the profitability has been restored. There are some things yet to come that we think will further strengthen profitability in a material way. So with that, I think all of you out here are pretty familiar with the franchise. We do operate across the western United States and we do it in a very localized fashion. This what we call a collection of great banks, with local management teams and we have those management teams working today and you'll be hearing from them a little later. We think it's a model that gives us a lot of competitive advantages. I love the story that Stan Savage, who runs the Commerce Bank of Washington, he's done recently about coming [ph] with me. He was -- he received a phone call from a colleague who worked with him in years past, a former employer, one of the large national organizations in the industry.
This colleague's in a private banking department called up and said, would you be interested if we were to work out a deal where we send you business loan referrals? And Stan said, you know when we worked together, when I was working here at the bank at your end, that would've been considered kind of bad form, to referring business loans to a competitor. And he said, well, the problem is nobody's there. They won't answer the call -- our calls. They won't give us the time of day and it really typifies the kind of product silos that I think you get in some of these very large organizations that are really line-of-business driven.
One of the things that I think we do really well is to integrate the experience with customers at a local level. And I can pretty well guarantee the kind of phone call that Stan received wouldn't be received here because we have a fabulous kind of causality at the local level among bankers who are working together as a team in local markets. It gives us a model that we think, what Vic Mulkovich [ph] used to like to describe as our international the locals and out local the internationals. We have a -- it's a very significant kind of community bank field and approach of the business. And by community, when I talk about community banks in my organizations, some people they want to have a really deeper roots in the community. It's not that we want to move things in a semi-professional, well, or anything like that. It's that the relationships are the core of what we do. It means having, being involved in the community, understanding where the opportunities are and building a great presence in the local market.
We have some fabulous leaders in this company at the local level. We try to share the best practices among these banks. We get together frequently and try to learn from each other. But the real decisions with respect to how we manage relationships at certain level very locally. We centralize a lot of the back office processes and non-customer facing elements of the business. So it seems like call centers, item processing, data processing, the wireless ACH, payments, treasury management support, product, credit exam, compliance, asset liability management, portfolio management, enterprise risk management, new product review, maybe controlled models, could produce the evaluation of the loan-loss allowances, consumer loan centers.
We have a lot going on centrally to support these banks with a lot of us -- we think get most of the efficiencies that you can have if you are running it as a part of this organization. We focus a lot on small-, medium-sized businesses for a couple of reasons. One is because I was emphasizing opportunities are better there. And most of the middle-market kinds of businesses that constitute a big part of our balance sheet really start off by definition that works in all that start off as small businesses. And our experience is if you can build strong relationships early on that the likelihood that you'd be able to have the kind of relationship that gives you more product and better pricing over the lack of relationship that's better if you start small.
So that's the model I think you all -- used to be familiar with that. And it's led to a maybe during a time where the industry has reputationally taken enormous hits, some very good things being said about us through the last 3 or 4 years. I think about the harsh environment this industry is in and I'm reminded of a story of the farmer, the professor and the banker who all show up at St. Peter's Day and wanting to get in and I think Peter first turned to the farmer and he said, okay, I want you to name the shipwreck, the powerful vessel, loss of civilian life. And at first, the farmer thought then that, I think that would be the Titanic. And Peter said, that's correct, come on in. Then turns to the professor and he said, let's see now, how many lives were lost? And the professor said, he thought for a minute and said, 1,307. He said, well, that's very good. He then turned to the banker and he said name them and that's how we -- it's kind of the environment we've all been operating in.
We're really proud of the fact that we continue to be named among the small handful of great banks in this industry in terms of the way we manage relationships. The 2011 Greenwich survey of small and middle-market businesses, we received 13 excellent mentions including overall satisfaction, excellent book categories. One of only, about half of other banks need on both the -- we get very high marks in treasury management. We're nationally ranked in terms of SBA production. We're the largest by the 400 or the seventh largest 7800 in the United States.
We made this past years having one of the fourth top teams of women bankers, something we're especially proud of, the north American Banker. With here, our local kinds of recognition and some of the presentations of the banks' CEOs will be a little later on. But I was especially pleased in May of this past year. American Banker teamed up with a reputation institute and they did a survey of a lot of consumers, trying to determine who is the most reputable brands in the industry and they used the -- the companies that have multiple brands, they used the most common brand name associated with the company.
And so #1 in the country is Harris Bank, the Bank of Montréal Corporation. Number 2 is Zions. Number 3 is Charles Schwab and then the list going on. But one of the thing that's actually notable to me is among banks, the leaders tend to be those that really do have a local focus geographically. And so we're very pleased with how we come through this reputation.
Our balance sheet, we'll be talking a lot about the balance sheet today. I won't dwell on it here. But we had about 70% of the balance sheet in loans. It's about 6.5 percentage points higher than the medium for an actual $10 billion or $20 billion in size. The other notable thing here is that we have, you hear a lot about this today, and I suspect, that a very strong core deposit base, 35% of our total liabilities are in demand deposits, 37.5% of our total deposits as of December 31. So what is really and it always has been a fabulous deposit base, more about that in just a moment. Our securities portfolio, we have issues with CDOs, you're all familiar with those. We haven't had issues with mortgage-backed securities because we simply don't own them.
So some of the issues, I think, some of the competitors are going to have, in terms of margin compression coming out of NDF securities and those portfolios, you're not going to see that coming out of that kind of a portfolio here. We have a very short duration in terms of our assets, a very short duration of equity. And this is naturally very asset-sensitive. We are that now. And one of the things I think is really a particular strength of the company is that we have one of the strongest margins in the industry.
We don't do it by extending duration and taking a lot of great risks. Everybody takes rate risks but by default, we are exposed to rates one way or another. But we're certainly not going to be hurt at some point in the future as rates start to rise. We have strong margins with fundamentally, really strong asset base and real priced loans that we think have a great compensation on our balance sheet. We had a strong focus on business banking, 76% of our portfolio is commercial and commercial real estate. I think piece of this is C&I and owner-occupied, which we kind of throw in the same bucket with all and some from the operating cash flows of businesses.
We do a fair amount of term CRE lending, we'll tell you a lot about that today. We think that the George fibers [ph] cleaned last night that there is kind of all these way than you do marketing and refinancings that need to take place. We don't have any maturity rate coming at us and we think we're actually quite well positioned for that. Our liquidity, very strong deposits are 92.9% of total liabilities. And again, demand deposits or managed demand deposits, 37.6% of total deposits at year-end. And that consistently been about 1/3 higher than peers in the industry. So that's certainly part of it, more than to it.
If you look at the liquidity positions, loan deposits, 87%, is just quite a comfort again there. And funded again at least with demand deposits with an on and off the nearest degree, high end of the industry in terms of a portion of our earning assets. And the thing is that we're no experiment in deposits until America does a fabulous job with really supposed to be the neck and neck within there. We're going to hear a lot about capital today. And fundamentally, what we want you to know is that we have raised a lot of capital over the last 3 or 4 years. We've raised 124% of our TARP capital in common equity, that's more than twice what the median is for other banks who paid TARP.
We've raised 47% of our TARP outstandings in the preferred versus 40% per period. So a total of 171%, so you don't want to think about the pricing ratios. That, as compared to 92% for the median total equity replacement ratio for banks who repaid TARP. And this excludes the conversions of the gain, the sizable gain we generated, we provided sublet holders the option to convert into [ph].
So that's not in these numbers. This is outside equity. Our capital levels are very strong today and particularly if we look at what happened in the risk in the portfolio, when you take lots of absorbing capital, tier 1, common, preferred, exclude TARP-referred here and our allowance for credit losses relative to total changeable asset, with less cash and treasury security. So it's sort of a very broad definition what we consider to be risk assets.
We're about 40% stronger than we peer deemed. And that number is -- that differential continues to widen. And so we think that, like very broadly, and by virtually every other measures that as capital levels today are quite strong. We want to let you know that despite CRE concentration and so many distressed geographies, we've actually fared better than most of our peers in the industry through the pipeline coming from that program.
This slide shows the cumulative net charge-offs beginning 2007, loans annualized for the 15 quarters ended September. Our -- update this for the end of year. I'll tell you that our average net charge-offs over the last 4 years, 2008 to 2011, again 1.90%. Now that actually happens exactly for Wells Fargo definitely the last 4 years. So there is sort of one fundamental difference and that is in 3 of the last 4 years, '09, '10, '11 Wells Fargo had Globe Wachovia asset in the denominator. It's taken a lot of the loss content in the net portfolio in the purchase mark when they acquired that bank. So I think apples and apples, their number would've have been a higher -- ours was a little higher because we had a little of the same phenomenon from a some sales language we had with the SEIC. But that's pretty modest compared to some in this list and you know with Wells Fargo, BB&T and TNT and a couple others.
And so given the fact that we were operating, first of all, admittedly and if we should be whacked the size ahead, [indiscernible] we had too much construction development exposure coming into the cycle and then the fact that we have -- a lot of that was in arguably, 2 of the maybe the 2 hardest hit, certainly 2 of the 3 hardest hit markets in United States, in Nevada and Arizona. We think of the fact that truth is with charge-off levels that we're a little better than the median and much better than the loan weighted average for the industry is really a sign says here, that we've been through a lot of stress, everybody's been through a lot of stress. The loan portfolio, we started with some reasonably fundamental good underwriting to start with that left us in a market like Arizona in a much better shape than may have been a phase in, I think, some other companies whose numbers were probably smaller market share that we actually have much better experience than some of them.
Credit quality is improving and it has been better than peers. Nonperforming assets as a percentage of loans and OREO are trending down and they're now better than peers. I pointed out that we're better than peers despite the fact we actually have about half as much consumer exposure as a lot of peers. And nonperforming assets in consumer portfolios are simply, generally calculated a little differently. We have a card portfolio, for example. You don't classify companies in the past year. If things go pretty quickly like the charge-offs, they're not lingering and nonperforming for a long time. One of the majors of this I think if you look at the most recent quarter for the state that's available in September of 2011, our 90-day loans still accruing as a percentage of total loans was 0.27%. And if you look at the average for the largest 4 banks in the country, their number was 2.78%. So we're about 10x better.
The difference would largely be in this consumer portfolio. Which simply contributed to that. And so having nonperforming assets better than peers for the smaller consumer portfolio I think is a particularly noteworthy thing. Net charge-offs the last year has been better than peers each quarter. And in fact, if you look back to the last 16 quarters, we've been better than our peers in 10 of those quarters, it's just about filed even, 3 to 3 other quarters and worse, in 3 other quarters. And we had a couple of blowout charge-off quarters.
But by and large, we've actually been performing better on a pretty consistent basis. Credit quality trends, as measured by classified loans again, they continue to improve the new inflows shown here in the green line. It's also been coming down and net charge-offs will continue to come down. Net charge-offs in the fourth quarter is about $95 million.
We expect that they'll be roughly 2/3 of that amount in the first quarter here. So it's certainly not been inclined with this very specific earnings guidance but we do -- we're pretty comfortable that charge-offs in the first quarter are going to be about 1/3 that made it would it appears right now about 1/3 maybe in the fourth quarter. The fact that loan trends has been improving by product type, these are showing in each of the product types and also by banking subsidiary affiliates, it's been across-the-board, these are improving and the loss content is also decreasing as well. It’s now about 1/2 of the level it was at the peak so the trailing 12-month loss is coming out of classified loans. It's coming down and the largest -- pretty good indication, the largest portion of loss has been out of the portfolio, and we think it's getting better as time goes on. We have done a lot to strengthen credit risk management in the company and to fine-tune what we view here as a fair amount of process and [indiscernible] for a little later. But the big story here I think the 40,000-foot level is that construction development loans, which were about 1/5 of the portfolio at the peak today are roughly 6% of the portfolio.
It comes down dramatically and that's important because they generated about 45% from all of the loan losses through the cycle. And so de-risking that has been a priority and we think we've got that largely accomplished now. Due to largely the credit improvement, we've returned profitability in 2011. It's been profitable for the last few quarters, reserve releases are obviously part of that story. We're not where we want to be, but we're making steady progress and as charge-offs come down that drag from nonperforming assets and most notably, I think, the -- some of the drags from credit-related costs that are going through the income statement but not going through the provision line come down, that will continue to boost us rather substantially.
If you look at the fundamental, the core earnings machine here, pre-provision net revenue has actually been reasonably steady through the cycle. Reserve releases have still ways to go. We think that -- I mean, you can kind of do some math and if you take the numbers I just gave you about what we think the first quarter's going to look like, I mean we're going to be more than I expected, at north of 4 years of coverage of losses. We expect to see a continued pressure burden on our reserve down. We're trying to be conservative in when they do that. But that will continue to feed that for a while as other credit costs, say, OREO-related expenses and other credit-related expenses continues to improve.
When you look at our primary revenue source, net interest income, it's been remarkably stable and we talked on our calls about the impact of cash on our margins if you adjust for the impact of cash buildup that's been taking place. And add that back into the margin, our core net interest margin, we define core, is if we take out one of the subject and what's been going on, as well as from the additional accretion on FDIC indemnified asset, which has been a positive. So if you take out a couple of numbers that you think or know are not going to be a permanent and creating some volatility. And adjust for the cash piece of this, at core, the cash adjusted core net interest margin has been remarkably stable. It's ranged between 4.44% and 4.52% over the last 7 quarters.
And there is coming -- there's some pressure on margin. Undeniably, we're not immune to the effects of this yield curve and what it's doing to the industry. But we think we're probably in a little better shape than most in the industry and we start again with a core net interest margin that didn't accomplish by taking a lot of duration risk in terms of lift from rising rates and it should remain very strong on a risk-adjusted basis, which you see on the right-hand side these, this simply margin adjusted for net charge-offs. But we -- again, really, it's a very strong, independent industry. And as charge-offs continue to come down fundamentally, we think it's going to be economic margin -- it's going to remain pretty strong.
Efficiency ratio, 69%. We know it's too high, clearly. We -- we were working on that during it's probably somewhat, flatly closed to a dozen branches last year, expect to have about another 8 closed in the first half of this year. We're looking at a lot of things. We're interested in measure at same minute every day. The last 2 years we've actually saved 3 million kilowatt hours annually of electricity consumption through some things that we've been doing. We're looking at a lot of those different initiatives and reaching banks trying to get costs down during a period where revenues is clearly a challenging industry. Holding cash, having what is actually a slightly negative duration of equity has contributed to, on the denominators side of the efficiency ratio, that we now needs to improve.
By the big chunk of this, as we look and compare this to where we were, say 4 years ago, leaving credit, FDIC insurance premiums, with OREO expense and very notably, with some compliance costs. We've added a lot of people to deal with some of the complexities and requirements coming out of [indiscernible], et cetera, et cetera. And we also know that our capital structure is too expensive. We've already been talking about that and we think there's a little improvement there, a lot more to the bottom line.
So key takeaways again, strong core franchise, strong capital levels, credit trends are improving, charge-offs levels that are below industry levels and continue to improve, core risks that we think has been substantially reduced and we turn to profitability. We are really -- I can't tell you how proud I am of the people who work in this company. They have worked extremely hard over the last 4 years. They've worked some very long hours getting this done. We're proud of some of these results that we posted in terms of how we compare in some of these measures to our peers. And I hope that we'll be persuasive in making that argument through the day. So with that, I'm going to turn the floor over to our Chief Financial Officer Doyle Arnold. Doyle?
Doyle L. Arnold
Good morning. So I'm going to talk about a couple of things, the next few topics, capital, liquidity and a lot about TARP and then about some of these improvement opportunities that are out there in the near to medium term that we think we should be aware of.
The first statement I'm going to make is that the capital and the liquidity are there, in our judgment, to repay TARP. The Fed may or may not agree with that statement. And we absolutely don't know at this point and I'm not going to speculate on that. We submitted our stress test and the capital plan for the process. It totaled 1,992 pages of text and pretty charts and tables with tiny prints and lots of numbers. And the Fed has been asking lots and lots of questions ever since. We think we have answered the last of their questions yesterday and we will now, like you, await the results.
I'm going to talk -- there's 4 issues really that kind of go into the Fed's decision. One is whether or not they are satisfied with our whole process around capital planning and stress testing and we have done a tremendous amount over the last couple of years to build and strengthen that process. The -- it's not just about building the stress test model but improving the data quality, improving the whole set of policies and procedures in the government's framework. That's part of all of that is how you get the from one number. Did we or did we not exceed 5% tier 1 common than the supervisory truck scenario to 1,992 pages of supporting documentation around that.
Second, of course, they have to be satisfied with the capital and that we have the emerged, the stress test results themselves. And then finally, the capital can be there but the cash may not. And so, we have alluded to how that might occur. I'm going to lay out a little more illustrative example of how it could be possible. And again, all these is caveated by saying the FED may or may not agree. I think realistically, there are 3 scenarios that could say your capital plan is not approved. They could say your capital plan is approved or they could say your capital plan is approved if and it can be whatever they want to make it to be. And then the answer is pretty clear, it's either or, we'll have to look at if there's an if associated, we'll have to look at those as we always do in the context of what we think is fair to the shareholders, as well as being very compliant with safety and timeless issues.
So I'm going to talk first about capital stress test that was highlighted on that side, we're going to talk about capital. We have gone from capital levels, pre-crisis, that were kind of in line with our peers that's a little lower than if you take all U.S. banks extremely [ph] specifically have the higher capital ratios. We've now built that to the point where we're, with or without TARP, we are higher than our typical peer group, the $20 billion, the $200 billion bank holding companies plus the well, the U.S. banks and even higher than all of the U.S. banking systems on average.
Relative to the specific banks, we are highlighted in the green on these 4 charts. The upper left is Tier 1 common, the upper right is all Tier 1 capital excluding TARP and it will be presented kind of a loss absorbing capital, which the total tangible asset plus cash without TARP and then the Texas ratio. We're the green bar. You can see the other names. The ones that are outlined in kind of the dash line reds are the 4 banks plus us that, in this group of banks, that have not yet repaid TARP.
So on tier 1 common, we're about the medium or a little to our left, setting on every other measures when you start bringing in preferred, other forms of capital, preferred, when you start bringing in reserves, and then you look at all of that in relation to problem, a measure of problem loans. We are well over into the top third, top quartile or in one case, the top position if, if I measure the capital adequacy.
I mentioned bringing in reserves. Our reserves have, as a percent -- as measured by the ultimate kind of reason for which reserves are there while all these charge-offs, they've always looked pretty good and we build the reserves a lot as I think you're keenly aware of over the last couple of years. I'd say we are now -- look at reserves to our charge-off ratio. We're well above peers and the banking system as a whole. And if you just take the last quarter, the fourth quarter and annualize it, we've got about 3 years of annualized charge-offs in the reserve at this point despite having released some of the reserves as Harris mentioned in each of -- in 3 of the last 4 quarters.
We stacked up pretty well under the proposed Basel III rules. The left-hand bar here gives you at the end of 2011, how we looked under the Basel I, rules of 9.57%, rounded to 9.6% tier 1 common and a layer of preferred on top of that, including TARP but a lot of other preferred as well build the total tier 1, up to a 15%. And then there's other risk-based capital above that [indiscernible] and et cetera.
If we strip out the AOCI mark, you get -- but leave in the trusts you get on the second bar, and if you then -- disallow our own trust-preferred and our own -- and take out the TARP. Soon we'd repay it, then replace it with nothing. We're still at 7.9% tier 1 common, about 9% total tier 1. And then a little bit of a capital on top of that. And we put in another bar to the right, on the far right that we haven't showed you before, which is what those numbers would look like if you added back the AOCI. Now why would I do that since AOCI, as you know, in other comprehensive income is excluded under TARP.
The reason is, and David will talk quite a bit more about this anyway later is that there's reason to believe that over the next year or 2, we will start taking back some of the AOCI mark which is largely attributable to the trust preferred CDOs that we own. Now those have been a source of increasing drag on tangible common. They have an effective risk-based capital ratio because which was under Basel I rule, it gets added back. And under Basel III, it won't be.
But if we start [indiscernible] -- basically if the fair value of March starts to recover for any of several reasons, deferring banks beginning to pay again, paying banks, pre- paying discount rates on distressed assets and including these particular distressed assets start to recover a bit, that market will go in reverse. Now we -- I would not expect this to recoup all of it. We showed you the effect of recouping it here but we do think there's reason to believe that some of it will come back.
And just to give you a little taste of what David's going to show you, if we currently are basically using a 3% cost of prepayment rate in the out years along these securities. And remember, there are incentives to the banks to prepay, particularly the larger banks because starting in a year both under Dodd-Frank trust preferred and say if this is issued no longer counts as, will be phased out as qualifying tier 1 capital. So it then becomes potentially adjust an expense of debt few as opposed to a few capital after that.
This is illustrative of what happens to the AOCI A market where you post prepayments fees increase. Here you got a 6%, you get $42 million, in fact, $79 million, 9% et cetera. We are using very high discount rates on some of the status [p]. In the footnote you can see on the lowest concepts that we have, it averages LIBOR of plus 33%. The highest, I think about LIBOR across 38%. So we showed you what happened if -- and the weighted average of the whole portfolio is about LIBOR plus 12%. That's at the end of the fourth quarter. And we showed you the illustrative impact of those discount rates coming down here by about 20% better, 40% better et cetera. You can see here the discount rate is a huge impact on AOCI.
Now looking at stress test results themselves. I'm not going to tell you what our stress test results were under the test scenario. I'm not going to beard the lion, as they say, by telling you exactly what we submitted to the Feds and say you're not studying. but I'm going to give your parts of the results under our stress scenario and I'm going to show you here how our stress scenario compared to the Feds who provide stress scenario in certain key parameters. Important caveat there on the top, this is not a forecast of our actual -- what we actually expect to lose.
It is a forecast under stress, under 3 different models that we built. One is kind of a top down look at the whole company regression model. And the other is, the second is the regression model built-up bank by bank for our major banks. And then the third one is a bottoms up model where we try to, using various purchase models, look at loan by loan by loan for construction development, for term CRE, for commercial, et cetera, what the loss impact would be if you want a particular long economic scenario to your model.
We weight those models equally. The -- Obviously, the first 2 has largely been stressified from data through the crisis. So the parameters in those models, are we think they're conservatively biased because they select basically the losses we incurred in 2008, '09, '10 and all the way up through middle of the second of -- and partly in the third quarter of 2011. The key inputs, just to give you a comparison with the Fed stress had home prices going down, 12% in the 1st year, this is a matter of public record, they publish their numbers. The first scenario we ran was more severe on housing prices, they had them going down 19% in the first year and cumulatively, 22% to about 20% to the Fed.
Our peak unemployment was a little bit less severe than theirs in the -- we're in the, where are we 8.6% now? We had it going up to just under 12%. The Fed scenario had going it up to just over 13% and we are pretty similar on GDP decline, about 4/10 of a percent difference between the 2 models. So if you're taking on balance, our stress scenario and their stress scenario were not that totally different. But Let me tell you what some of the results were. This is a chart here just to show you a few minutes ago but with one more set of bars added to it. The top part is just what Harris showed you. It's -- the red bars or the top or are at the top position of our loan portfolio going into the severe downturn that we've all just gone through. That's what it looked like in the third quarter of 2008, which happened to be at the start of the most severe 9 consecutive quarters of losses that we took. So we're picking the worst period here and the green bars are the portfolio composition at the end of the third quarter of last year, which was the starting point for running these stress models.
So as Harris pointed out, the construction development portfolio is down dramatically. The term CRE portfolio is up slightly, C&I down a little, and owner-occupied and consumer ultimately similar to what they were. The actual historical losses, as Harris pointed out came predominantly nearly 50%. What was the number, Harris, 45% out of the construction and development during that worst 9-quarter period. Our projected losses for the next 9 quarters starting fourth quarter through the end of 2013 are the green bar on the lower -- just on the right of that. And you could see it's dramatically lower, the loss severity is actually slightly higher than the loss severity on the portfolio because it's a much worse economic scenario. Remember, I think unemployment peaked at 10.5% during the last recession in 2009. It peaks at our scenario at 11.8%. So and you're taking housing prices down another 22%, et cetera. So the loss severity is slightly higher, it's not dramatically higher but because the portfolio itself is so much smaller, the loss content is dramatically lower.
The C&I loss content is also down a bit and you can see the rest are roughly similar in terms of total losses. But the aggregate is around $700 million less projected credit losses over the next 9 quarters under a very severe scenario that we think is conservatively biased than what we just went through. So the -- so to kind of tie that off, the next slide here is the top slide is just a carryover from the bottom of the previous slide and then the bottom part of the slide sort of sums it up.
In the third quarter of 2008, the beginning of our worst 9-quarter loss period, we had a little over $3 billion, about $3.3 billion of tier 1 common and reserves. And we incurred $2.4 billion of credit losses during that period. So we pretty well have the rates of our capital. Under this scenario, we go into it with about $5.1 billion of tier 1 common and reserves and the projected losses are 1.6, I said $700 million, it's actually, it rounds at $8.8 billion tier 1 losses going through that. So we think we're in much better shape. And you can -- for those who want, you can take those losses, decide what we're going to have to provide and we can get some idea what the impact on tier 1 common would be starting with 9.6% if we raise no capital.
And I'm not going to show you the results of ours but we were pretty comfortable that we were above the Cap -- the TARP level. So what -- we are comfortable with capital whether the Fed will be or not is for them to decide and I can't forecast that for you. But it's not just enough to have capital. We have to also have cash at the pan to pay $1.4 billion. You're all well aware, we don't have that much today so where does it come from. So I'm going to a slide that Harris showed you. We have cumulatively raised about $2.4 billion of capital, common and preferred. That excludes TARP.
We took $1.4 billion of TARP and we pushed most of that down to the banks. The banks now have very high, all of them, very high capital ratios, if we can take about 40% to 45% of that back, well over $600 million of capital repatriation and do a couple of other things, there is cash there to repay the TARP. So here's an illustrative scenario just to show you. At first, TARP redemption is subject to Fed approval and including approval of our overall capital plan, which includes all of those processes and government and things that I showed you. We've imposed 2 Other constraints here, just as an illustrative example, we want 12 months of time to required funding at any point in time to the parent.
In other words, we have enough cash to survive at least a year forward without any access to capital funding. And at the end of the day under our stress scenario, we have -- with this illustrative thing, we said all of the banks will have a tier 1 common ratio of at least 9% tier 1 total of at least 11% and total our risk-based capital of at least 12%, at all points in time, in each bank in that scenario. Under those constraints, starting with about $1 billion of cash, we can take about $50 million of preferred and common dividends from the banks in the first half of the year, repatriate a little over $100 million of capital. We issued $300 million of senior notes, largely to pre-fund the FDIC guaranteed debt that matures in June of $255 million, that's the last line in the bottom.
We could repay some 1/2 of TARP and we can see all of the preferred in sale and the preferred and common dividends at current rates and have $435 million-ish of cash at hand, which would exceed the 12 months. The second half of the year repatriates more capital, take the dividends, issue $300 million of what will be net new senior debt that still leave us with much lower current leverage ratio than we had pre-crisis.
We, being the rest of TARP and pay the dividend and end up with more cash at the parent. All of this will be subject to regulatory approval. That there is a path to repay TARP without a large capital raise and it requires a little patience and to do it. But it is doable if we're given permission. Any questions at that point, and then I'm going to turn next to some of the earnings improvements. Yes ma'am? Erika.
Erik Oja - S&P Equity Research
Doyle L. Arnold
We -- David is actually going to touch on the securities losses later. I'll repeat the question? Okay. So Erika asked what we -- what I -- tell her what the securities loss forecast was and whether or not the TRS is a factor here. The answer is under a stress scenario that's more severe than what I just showed you. One that was sort of forced to mimic the cumulative failure rate in about the last 8 years of the S&L crisis back in the '80s and '90s. Now remember, during the first -- this was a very slowly unfolding crisis because for those of you who are old enough to remember, there was a lot of regulatory forbearance in '82 or 3 or 4 or 5 or 6. And then, the reality set in and there were a lot of S&L's in the late '80s and early '90s. So if you get to a cumulative, nearly 15% default rate on the banking industry and we are exposed to our pro rata share of that, given our security, it would be about $350 million of additional OTTI. The actual scenario, our stress scenario without that forcing of that high. Because if I just run those -- that economic scenario that I described to you through, it's about $200 million of additional OTTI from where we are now. And so if we included, we frankly included the $200 million and all of our submissions at both the Fed and IRS, we shared them a sensitivity to another $150 million. We also shared sensitivities to removing the TRF entirely on -- and the net impact to that is it increases risk-weighted assets about $4 billion. But then, you have to net out from that the fact that, that OTTI would be taken on largely on the highest risk-weighted securities if you remove the TRS, the worst one. And so the net impact on at the end of the scenario is more like $2 billion, $2.5 billion of additional risk-weighted assets. Okay? So any other questions on -- yes?
Can you talk a little bit more about the building of dividend up from the subs? What type of confidence you have that you're going to be able to do that and which subs will be in a better position to do so?
Doyle L. Arnold
So I think everybody can hear on the webcast that one, right? Okay, so I don't have to repeat it. The dividend and the capital up from the banks does require regulatory approval. The -- largely because there are rules about dividend or repatriating capital that the banks are in a cumulative loss position and some of them are. But I would say, borrowing a -- look, if the -- I think it's fair to say that if an actual severe stress scenario actually does start to manifest itself, it is unlikely that we would ask to pull a lot of capital out of the banks. And it's unlikely that if we did ask, they would approve it. Despite what I showed you is that the capital ratios would be there, under the stress, to do that. We'd probably -- so it's a matter of maybe timing, maybe the scenario would get delayed a bit. Correspondingly, if it doesn't manifest itself, then it ought to be particularly with the credit conditions continue to improve, it ought to be possible to take much or more out of the banks by the end of this year. And I think it's fair to say it comes largely from the banks that are larger, from Zions Bank, from Amegy, from California, from Nevada. But Nevada has already, I think you are aware, sent us back $100 million and there's a bit more coming back from them later in the year. Yes?
Two things. What's your tolerance on the whole 2013 if the debt comes back and does require some type of capital ratio pretty clearly that you don't think need one? And could you share with us, how do you think this plays out? In terms of -- is the Fed going to release your results to us?
Doyle L. Arnold
Harris is over there, shaking his head. No, don't go there.
Just timing. I mean, you're going to find your results that close to the 15 or we hear...
Doyle L. Arnold
Well, I'm not even sure of the timing, Steve. But initially, we all thought it was going to be March 15, the dates. I talked to an investment banker the day before yesterday who thinks that it may slip a couple of weeks and the banks make hear kind of in the week following that but they may not -- it may be embargoed and nothing is really released publicly until early April. But our tolerance for holding charge, I don't really want to -- I don't want to -- you're asking me to speculate on the various kind of in betweens, yes, yes, and I think it depends a lot -- it'll just depend on our assessment of what yes is and what the conditions are and there's no -- again, I'll fall back on comments I've made in the earnings press release a couple of times. This is not the forum for me to negotiate with them, and I'd rather not go there.
All right, I'm going to move on to earnings and we'll have some more time questions later.
Doyle L. Arnold
The -- there are nearly significant improvement opportunities if we reduced credit-related costs not the reserve release part. That will actually be a drag. But -- and even more importantly, if we can reduce capital, reform and normalize our capital and financing structure. So here's a snapshot of what the company looks like for the second half of 2011. We've got pre-tax income from the banks, and you can see, the banks are making quite a bit of money. Some of that does come from reserve release, obviously, with the banks. But even if you netted that out, they will all essentially breakeven, and in most cases, profitable. I didn't show you the 3 smallest banks here, I kind of lumped it in with eliminations, there's no hidden there. I just didn't want to make the charts incredibly complex. But net of all that pretax income annualized, taking the second half numbers, was $811 million. But then you've got some very severe drags on that. Current debt in total was about $201 million pretax drag. Taxes, a little over $200 million. Net income after taxes of just under $400 million on an annualized basis. But preferred dividends annualized were $177 million. And that's both cash and noncash, in both the debt and in the preferred dividends. So the preferred dividends include the accretion of the warrant value so that effective cost of TARP, for example, is about 6.7%, not 5%. In the sub debt, it includes the amortization of the discount on the modified debt, which raises that, the trough of that debt to somewhere in the 10% to 11% range assuming that 7.75% senior notes have an effective yield of about 11%.
So what are the improvement opportunities? Okay. I can't tell you what the bank ratings are and I can't tell you what the components of the CAMELS are, that's not legal. But I will let you to know that if you are -- if you have a component of composite ratings less than 2, there are extra costs associated with FDIC insurance, and I'll show that to you through the OCC. I think it's reasonable to believe that within the next year or so, most or all of our banks will get at least 2 in every relevant category. The net effect of that is an after-tax pick up of $10 million. Those extra costs were about $16 million, annualized pretax. This is the number you haven't seen before. If we take the total -- the 2 lines, we do break out on the income statement, OREO and another credit-related expense, they come down a lot. If they came down under this 75% from where they were in the second half, which would still leave them well above where they were pre-crisis, that's a annualized after-tax favorable impact of the $60 million. The net of those 2 is about 70, which is the largely offset by normalizing the provision to, pick your number, I pick 40 basis points, annualized provision, is a more normal rate. We actually, if you know, provided essentially 0, so that's an actual increase in cost of about $76 million.
The net of securities gains and OTTI losses, if we just took those to 0, that would be a pickup of about $13 million annualized. And then there were 3 unusual items that we described and that happened to hit in the fourth quarter. One was extraordinary legal expense. One was a pension or a benefit adjustment, and the final was consulting expenses that we paid on a capital plan to reverse -- if you just normalize those to 0 and annualized, it's at $18 million. So you got $39 million after tax.
More importantly is your capital and financing. Now we showed you -- this is an updated version of a chart we've showed you before where we just say, here are all the pieces. Here's when they're called. Here's what they cost. We couldn't do all of this without replacing some of this, but you figure it out. I'm going to give you a little more roadmap on how you might figure it out. Let's assume, for argument, that we don't have any improvement in our ratings over the next 2 years, say when all of this -- what I'm about to describe is doable, that something handles this junk so I'm not assuming a lot of lower financing cost for what we do refinance. But if there is an improvement in ratings, some of these costs that I'm about to show you improved further. So let's assume we don't draw down Tier 1 common. It stays at 9.57%. We might have a 2% layer of preferred on top of that to a total Tier 1 of about 11.6%, a 1% layer of sub debt on top of that, which is 12.6% plus of total capital plus whatever reserves accounting for that. And then we had 2% funding of first rated assets funded by senior debt. So that gives you basically $4.1 billion on a Tier 1 common, $860 million of preferred, $430 million of sub debt and $860 million of senior debt. If -- to repay TARP, the cash cost is $70 million. The cost of that 2% layer of preferred, compared to what we're paying now on all of the non-TARP preferred, if it picks up at $29.5 million, the cost of the sub debt, compared to what we're paying now on all of the sub debt, is a pickup after taxes of $56 million. And the cost of that senior debt is about $15 million less for a total pickup of $180 million after tax. And again, refinancing, we could issue preferred today at around 9% sub debt somewhere in the 7s -- a mixture of short term, medium term and a bit of longer term of senior debt, it should come in somewhere around 5%. If you add up all of those pieces, it's about $600 million less cash, or less total capital and financing, externally we have today. Then that's the $600 million I took out of the banks and we paid TARP with. That's basically the net difference. So if you really sat down and work it through, it all balances out. This could be done. And you add up the pieces, you start with the $219 million of net income to come on the run rate second half, add the $39 million in the credit related, add $181 million in the capital, you get the $467 million of net income to common. The Tier 1 common was $4.1 billion. That's 9.6%. It's about, as you know, 6.78% tangible common. But if you strip out the excess cash, it's probably more like 7.5%% to 7.75%. So you get to -- that then gets you to what no change in earnings or costs for our balance sheet to about a 10.6% return on Tier 1 common or about a 15% return on equity on tangible common, if you back out the goodwill from that number.
There's -- and the key thing is rolling net interest income to remain stable and I want to go quickly because we're a little -- running a little behind. Basically, I'm going to just describe the kind of pressure so we can skip some of the detailed slides here. There is about 4 to 5 basis points a quarter of downward pressure on the margin over the next year or so, before we get to offsets to this but usually we do take negative pressures, right? One is the rate resets on long reset loans that were basically 5-year variable rate loans that were made in 2007 and 2008. That is one of the negative sources. And we have a number of those loans that we'll be resetting, and they're resetting at lower yields or lower rates than the rate -- the spread's the same but because basically LIBOR is so much lower now, there's a drag there. And there's a drag for maturing the floors, if you can't replace all of those floors with [indiscernible] assets. The total drags there are about, as I say, 4 to 5 basis points a quarter over the next year. It would take converting $400 million to $500 million a quarter of that excess cash into loans, a net loan growth of $400 million to $500 million a quarter, to offset that if you assume some reasonable yield or spread on the loans, similar to what we've been achieving. Now this is -- there are sources of growth and there's sources of shrinkage in our loan portfolio. This is an updated chart you're seeing. The loan growth, in general, is improving. It's not improving as much as this chart indicates because there was a lot of window dressing on the part of customers at the end of the fourth quarter, which drove those new loans, you can see the spike up there to about $650 million of growth in the C&I, churn CRE and consumer portfolios. Several hundred million of that has been paid down so far in January and the first couple weeks of February. But we think the general trend is positive. It's running now at probably an average of $400 million a quarter, and you've got the drag from the reduction in C&D loans and FDIC loans, it's giving less each quarter. So basically, if over by the second half of this year, the drag is down to a -- closer to 0 and the production stays where it is or a little higher, by second half of this year, you have enough loan growth to offset those drags.
The pricing overall has somewhat -- is rather stabilized. This is a long-term history of the pricing of those new loans. It's been spread over mass maturity. Cost of funds has been in 3.25% to 3.5% range for 1 year. It's that way up during the crises, it's come down and somewhat stabilized. So $400 million to $500 million of net production, net growth at that spread would be enough to offset the margin drags. And there's a little bit of room still to go in deposit pricing. So I think we'll maintain our ranking as one of the strongest margin in the industry. I think the likelihood is maybe a little bit of a compression in the first half of the year, followed by a little bit of rebound in the second half of the year, so that net interest income, overall, may be roughly flat to last year.
And that's what it -- that was -- and then probably some growth after that. And as you'll hear from the banks, pipelines generally remain pretty strong and so there is reason to believe that, that growth can continue.
So and then finally, as Harris mentioned, we do remain highly asset sensitive. If the fed's wrong and tightens prior to late '14, some time in '13, the leverage that we have for rising interest rates in this portfolio is rather huge, as we've illustrated here on this slide on Page -- what is it, 58. So that's a quick -- a very quick summary of those capital liquidity and earnings. I'll take 1 or 2 questions, and then I think we're going to have a break and turn it over to Ken to credit. Let's start here and go back there.
Just going back to Page 47 where you show that the amount of potential upside from the delivering the capital structure. Clearly, the D car is a big hurdle that has to be cleared before you can start stepping into that. But what should we expect in terms of kind of the time horizon to get at some of the stuff like let's say can you get over the C car hurdle like we expect? And then what's the time horizon? Should we immediately expect some of this refinancing to occur or is this going to take years?
Doyle L. Arnold
Well, most of this stuff is -- do you have a follow-up on the same question or you just want to get the line? Okay, next question will be back there. All of the things that are outlined here are, for the most part, doable between now and about 2 years from now. Now getting -- I'll just give you the mechanics without speculating, getting TARP repaid in full is essential to touching any of the other preferred, unless we were to issue replacement capital of equal or better quality. So this will come into play, for example, with the Series E preferred, the third line on Page 47, which is callable at the end of June of this year. And if we haven't fully repaid TARP by then, the only way to call it would be to issue $143 million of either perpetual preferred or common under the TARP rules and then required going to Fed and the treasury. Some will say in are not in our capital plan, those are the mechanics. If it doesn't -- if it's not called at that time, it will reset at a rate that will be in the 10.5% range, where it is today and not be callable until June of '14, so about 2 years out. The Series C preferred, which is in line below that, is callable in September, I believe, and that's a very -- that's a much larger issue. And it is has been callable in whole or in part at that time or anytime basically thereafter. It doesn't have this kind of rolling reset to it. The diminishing amount of sub debt matures in -- current sub debt matures in '14 and '15, and that's again is costing us, on average, about 11% net, will actually be a little bit higher this quarter because we have a bit more sub debt converted than has done so on the last couple of quarters. And then the 7.75% 5-year senior notes that we issued in September of '09 mature in September -- it's not on this chart, but they will mature in September of '13. And those, the effective cost of those is 11% because they were issued in with a discount. So most of the things on this page and one more thing not on the page, the senior debt financing, are touchable between basically June of this year and the end of '14. So that's your time horizon. Question back there?
Second, the margin discussion and your loan growth commentary, what's the argument against getting a little more aggressive on pricing in C&I, growing those balances is stronger today and we've still got someone liquidity and then maybe a year or 2 from now, widening those spreads just a little bit to support the margins of that?
Doyle L. Arnold
Well, the argument is, it may not be as easy. One, is that it may be hard to selectively make those concessions without it becoming very widespread. And that's a difficult management challenge and maybe some of my colleagues at one of our banks or Harris will want to address that further. It may be also harder to tighten that pricing again for those same customers when conditions are different. We're not -- we're trying not to lose really good customers over a small change in price. I think you will hear that while pipelines are strong, because of the competition, the win rate on new customers is lower than it has been historically. Because other banks are kind of in the same -- some version of the same situation that we're in with a lot of excess liquidity. And so if there is a feeling I think that if you if you cut -- if we were to cut 25 basis points, they just match the cut. And Harris, do you want to say anything more right now about that, or any of you guys?
Well, I just -- yes, I mean, we talk a lot about this. And I was mentioning the other day to some of our folks on some of our leasing folks, so if we were to change our hurdle rate by X and reprice, what do you think that will do to new volume? And I said, well, if we dropped our pricing about 100 basis points, we think we could increase our volume by about 35%, 40%. I wasn't sure I get the math and figured that the net effect of that would be to -- assuming we have to do all the new production because I'm really not sure you could do it very selectively. I was actually to reduce net interest income and increase capital allocated by about 35% to 40%. And so it's easy to say, the execution is skewed a bit. And one of the things I don't want to do is create a culture that says the price is little. I don't think that's how you create value long term, and I just want to be we don't get panicked and -- as likely to be reasonably short term phenomenon, I believe, because at the end of the day, I think one of the silver linings to all of this, Dodd-Frank, et cetera is that the playing field has not only been leveled, it's actually, in some respects, has been totally away from the largest institutions the capital we're going to have to keep. And as their balance sheet actually starts to grow and they start to do the math, some of the pricing we're seeing out there and I felt I can demonstrate, on a 100% risk weighted asset, you have to get about 160 basis points just to meet the cost of equity. And that's assuming you have no overhead cost, no credit cost and equity and deposits, no sort of debt or anything else from the capital structure. And I don't think the current pricing environment we're seeing is actually reflecting that. I really don't want to change [indiscernible] culture but I think it served us really well and to do something that could be near or short term. But potentially I'm sure that's playing out everybody certainly this year in terms of still trying to be very careful that we have to hold on to the core franchise. We have to make some adjustments here and there to do that some margin pressure. We'll occasionally see something we really want to go after. We'll be more competitive there, but going out and saying, one of our guys said the other day that if you give me a green light, I know that, I mean, the first 10 calls I make are going to be to customers saying probably something that doesn't make sense to us. So that would be my perspective on that.
Doyle L. Arnold
One more question, and then we'll break. Yes?
Doyle, this is talking about some of those long-term profit improvements again that you outlined on 49. So you mentioned that the company will remain very asset sensitive and at some point, will hopefully have rates. I'm wondering if you can give us a kind of a generic view on that 467 you guys show about adjusting a lot of these non-core capital structure with a some type of normalized rate environment and give us some perspective on where you think all-in earnings power can be?
Doyle L. Arnold
I mean, the best I can do for you, I think is, James, you're in control now. The rate sensitivity chart which was balanced at the end of this -- oh here it is, yes. If you had a parallel shift and your interest kind of up 100 basis points, we pick up 5% net interest income, about 12% if it's 200. And that's probably not -- what's really likely to probably happen is not a parallel shift but I would think that long rates are going up more than short rates. And there may -- there is a possibility that the debt could lose control before it launches it on the long end. So that -- there's you take 10% of net interest income, 5% to 10%, that's a pretty big number. I haven't added it up here, but I think you get to returns on intangible common in the very high teens, at least, under that scenario, with no -- assuming that we basically have to maintain 9.5-plus percent Tier 1 common throughout. And that's with the existing balance sheet. That's not with -- if you think about it, there's a -- unless the Fed loses -- I mean, there's 2 reasons the rates can go up. One is that the economy really has firmed up and is growing and the Fed starts screening this liquidity out and tighten the rates in that environment, not only do we have rising rates, you'll have loan growth. And which is probably further to leverage the pop [ph] from the rising rates. Little more if the -- in the Fed loses control, inflation fears the long end scenario, there may not be loan growth in that scenario, but we should still get some margin improvement just from the rising rates.
And just a quick follow-up. Harris pointed earlier about 36% of the balance sheet is funded by BDA, can you just have a little perspective on how you guys could see that playing out over time. Do you -- obviously, loan growth has started but there's still great deposit growth, so how do you envision kind of keeping that liquidity or do you bake it in that scenarios there [indiscernible].
Doyle L. Arnold
Yes, notice the yellow footnote at the bottom. We -- this is great sensitivity assuming that essentially all of the growth in commercial BDA accounts and existing accounts, this is a 58, for those of who are of you are looking for it, that has occurred over the last 2.5 years or so, is reversed in that scenario. In other words, in a rising rate environment -- or what's clear is that right now, businesses are sitting on a lot of cash. Particularly our commercial BDA, the balance is just continuing to grow faster than we can run off interest-bearing deposits to offset that. In a different environment, businesses are going to begin to redeploy some of that cash into growing their business. They will also have other investment opportunities potentially other than free checking. And also at the end of this year, you have, unless there's a new congressional action, the unlimited guarantee on noninterest-bearing transaction accounts will go away. So we will be very, very conservative. We've assumed essentially that all of the run off runs out. If it doesn't all run out, we're even more rate sensitive than the these charts show.
I was just going to expand on what you just touched on. This question over here about the excess liquidity, the $6.5 billion, nobody is more painfully aware of having $6.5 billion in your checking account than I am. But there are couple of things you have to think about and Doyle just touched on, but then stopped [ph] there, but one, we just paid a presentation that we think we can pay off TARP by essentially net raising $300 million of senior debt. That means $1.1 billion is coming out or ultimately comes out of the follow-through of our Fed account. So of the $6.5 billion, there's $1.1 billion. The other thing is, we know that from our studies that $6 billion of this excess cash, about $5 billion to $6 billion is excess balances in corporate checking accounts that wasn't there prior to the unlimited guarantee, which Doyle just mentioned, which goes away at the end of the year. Now what none of us know is when this -- when a safe place to put your corporate balances, in other words, it's all insured by FDIC insurance, when that goes away, none of us really know how much of that excess money is going to go away. I'm pretty sure it's not $6 billion, I'm pretty sure it's not 0. Some amount is going to go away. If you assume the middle number, that's another $3 billion. You assume a $1 billion of loan growth, that's $4 billion. You assume we're going to pay back TARP with $1 billion, that's $5.1 billion. This excess cash can actually dissipate fairly quickly, and we've been very careful in managing our liquidity. Not to get caught with a lot of long-term securities or other ill liquid asset so that we have a problem at the end of this year.
James R. Abbott
Okay, we're going to go ahead and take about 5, maybe 7 minutes. It's going to have to be short to keep us back on track and on timing. But we will take a few minute break.
Men's room is down to your left, and ladies to your right.
James R. Abbott
Okay. Well, I think we -- it's been a long time since I was -- when I was watching TV, when I was a few years younger, you'd see these -- whole screen would come up, technical difficulties. And that was really frustrating. And so we haven't seen that in a long time, actually. So television studios have gotten a little better. So we're having technical difficulties with the slide presentation on our end. But because most of you, I think all of you have the book, we're going to go ahead and get started. So you may see people moving around a little bit, trying to get that going.
Anyway, so the next 2 sections of the book are -- the first is going to be Ken Peterson, and he's going to run through an overview of credit quality, which Harris has done a bit of that, a deep dive into our commercial real estate portfolio. And he'll tell you what we're going to say and I'll say that I do see some estimates, maybe from some of you in this room, some of you not in this room perhaps, that still think we have mountains of losses that come out of the construction portfolio and so what we're going to show you for the first time is a row forward of what our construction portfolio was at the end of '07, loan by loan, and what that balance is today. And hopefully, you'll be pleasantly surprised. And then after that deep dive, and then we'll talk about the process changes to the credit culture, how we're trying to streamline things and simplify things, make sure that we can get more data so that we can understand the top-down approach a little bit better than we did beginning of this last cycle.
Then finally, before the next break, we'll have David Hemingway spend some time on the CDO portfolio going through that and how we think we can get some of that capital back over time. So with that, I'll turn it over to Ken Peterson, our Chief Credit Officer. Thank you, Ken.
Kenneth E. Peterson
Thank you, James. That's pretty much my presentation, any questions? Well, I appreciate your coming and as the credit portion of the presentation, this is the caffeine section, so make sure you've got some. We're going to break this up into really 2 sections and talk about the portfolio and then what we've done with organization over the last year and since I've met a lot of you before.
The portfolio overview, as you've seen already, the credit metrics have improved in all loan types, in all geographies. What is significant, the problem inflows continue to slow. The resolutions are, the vast majority of them are favorable. The charge-offs are declining and the loss severities are declining as well. And our loan loss reserve is ample, and I think you'll see better than most of our peers.
And looking at the total portfolio, the balances have increased and more importantly, I think for the company, to a greater extent, our commitments have grown due to the growth in new business, primarily in the commercial real estate area of Class A apartment and construction loans and our strong markets. And in our C&I portfolio, in the energy sector.
So from a credit perspective, we're seeing new revenue opportunities. And of course, our underwriting standards remain strong, and bad news, of course, are our loans. So I think from a Chief Credit Officer perspective, this is a good time. You'll see in the pie chart on Page 63 that the portfolio is balanced by product type. And in the upper right-hand of that slide, the delinquencies, NPLs and classifieds are all dropping.
Moving on to Slide 64, the Commercial Real Estate. The net charge-offs are still higher than the total portfolio, but generally, reducing at a higher rate. The gross commercial real estate charge-offs actually tended down 9%. That little click up in the fourth quarter is because we didn't get quite as many recoveries, which is a very lumpy indicator from quarter-to-quarter. But again, at the upper right-hand corner, all the problem loan metrics are improving.
In CRE, the total CRE has come down 26%. The term CRE, however, has gone up 26%. And then the resi C&D , the commercial C&D, land and other land, are all down by significant percentages.
Moving on to Slide 65, taking a look at the Commercial and Industrial portfolio. C&I loss rates are on par with the overall portfolio. And you'll notice that National Real Estate accounts for 14% of the portfolio, but it actually accounted for over 25% of the charge-offs in the fourth quarter. And we have, through the management that the DSMB [ph] addressed that head on. They've designated a new Chief Credit Officer for oversight of the National Real Estates portfolio. There are no new loans in '12. High risk states where we took a bath, limited the portfolio to the 4 main asset classes, apartments, office, retail and warehouse. We're not lending on any collateral over 30 years, and there were a number of administrative updates and oversights parameters put in place for operating that going forward.
Moving on to Slide 66, the Consumer portfolio. The HELOCs are performing well. All the problem metrics are improving. And as you may recall, our HELOCs are generally first lien and primarily relationship-based. You'll see on the pie chart, the ref loan, which is short for home refinanced loan, is another first and another relationship product of shorter amortization and lower loan-to-values. This product was actually the brainchild of Harris, and it has performed very well. The large percentage of our HELOCs are first lien compared to many of the other banks that have primarily second lien positions.
Also new recently, there is a centralized management of the home mortgages. Gentlemen by the name of Craig Waldric [ph] is now the Director of Enterprise Mortgage Banking. And after that actually, Chief Mayo and Bruce Alexander, 2 of our CEOs came together, put together a program to try to centralize this effort, rationalize it, reduce the cost and drive consistency across the enterprise. So that is a very, very positive fact.
In this portfolio, the mortgage products generally follow the Suddy [ph] and Fannie guidelines and we're centralizing a lot of this underwriting in our retail loan centers. So I think we see brought improvements in all categories in 2011 and expect the same going forward. Just a footnote, we have really no significant exposure to student loans. It makes my job easier.
Moving on to Slide 67, I think you've seen this before. The asset quality improvement is broad-based. Slide 68, you'll see the same types of curves. And what we're doing, and I'll talk about a little bit later, is to create an infrastructure where the next downturn that comes, the next economic debt crisis that hits our industry, we won't be seeing these curves in this form going up so high. We think the infrastructure is going to help prevent that. But again, Harris touched on this earlier and the story is the same. I think you also saw a slide earlier on the capital ratio improving, so I won't get into that too much, the story is consistent.
This is on Slide 70. This is one of James Abbott's slides. For just over a year now, the SEC requires reporting of graded loans in our 10-Qs. Zions follows the regulatory definitions for its grade. At the left chart, the ratio of past graded loans to total commercial loans is improving. On the right chart, Zions compares well to bank peers that report the same information in their 10-Qs. So that's good news.
Slide 71. Again, a consistent story. The classified and nonaccrual loan inflows continue to decline at a significant rate. This is a result of a couple of things. Major efforts on the part of our CEOs to address the problem loans, very active management, some very successful resolutions, and to some extent, an improving market in some of our markets give us a little bit of a tailwind. I think they will continue to decline, but the rate of decline is obviously going to reduce.
On Slide 72, this is another of James slide comparing classified loans and inflows to loss-absorbing capital. And it's all in an improving trend.
Slide 73. The left chart, at the same time that we were experiencing the classified loans ballooning, our loss severity was very large. Now we see the loss severity dropping as well as the reductions in the classified loans. So there's a double whammy positively. The right chart, the orange line shows how many of our nonperforming loans resolved, 31% this quarter. And of those that were resolved, 68% were paid off, paid down or put back in accrual. And those categories are our definition of a favorable resolution. The unfavorable resolutions would include charge-offs, charge downs and valuation allowances and property held and OREO.
On Slide 74, our net charge-offs continue a step down. The first quarter 2012 forecast were based on the individual bank estimates, which in turn themselves, are based on a loan-by-loan analysis. So we're pretty confident in the forecasting of the [indiscernible] grassroots process.
On Slide 75, our allowance for credit losses are consistently more conservative than the industry. And this data is really from the call reports and I think our peer groups, I think described before, banks between $20 billion and $200 billion overlapping our footprint and then we've also added in Wells Fargo and U.S. Bancorp.
So the key takeaways are the credit metrics have improved materially in all loan types and geographies. Again, our problem loan inflows continue to slow, our resolutions are favorable, charge-offs are declining, and the loss severities are getting better. And our loan loss reserve is very strong.
Moving onto commercial real estate, which has always been a concern of people looking at our bank. The key commercial C&D takeaways are we have strong improvement in our problem loans, reduced concentration in C&D, the old vintage stuff is pretty much gone and we are experiencing very cautious growth in newly underwritten C&D, that one of our CEOs, I think it was David Blackford from California Bank & Trust commented that this is a time in the cycle where we may not see as good real estate lending as we have for many years. So being intelligent in that area is another opportunity for growth where we are conservative.
Slide 79, you can see that through our active management and improving markets that I alluded to earlier. Our C&D portfolio has stepped down materially from its peak. Interestingly, the ratio between land, the commercial and resi C&D has remained about the same as all has come down. The largest reductions from the fourth quarter '08 to fourth quarter '11 were, in order, Texas, Nevada and Arizona, good news for a credit officer.
On Slide 80, the majority of our remaining construction loans are in healthy markets. We still have construction on the books, not enough to break the bank, but where we do, it is in our healthier markets. 48% of our $1.9 billion in C&D is in Texas and Zions First National Bank Utah and Idaho footprint. And only 15% of it is in the Nevada and Arizona territory, which is our toughest markets.
Slide 81, again, I think this is the same story you've seen before in other forms. Same slopes. Again, we're going to hope not to have those slopes during the next downturn.
Slide 82, the nonaccrual and net charge-offs continue to decline as well.
That's singing the same song over and over again.
Slide 83, I wanted to walk you through. We've actively managed the C&D portfolio to maximize shareholder value. Here's how it happened. In December of '07, we had a balance of $9 billion from the call report, residential and commercial construction, land, lots and new development and a load of construction, not including any farm lending. Then we had a -- we charged off $1 billion from that $9 billion in total. We go to the right, we paid off $6 billion, and that could include some OREO. And then significantly, that $1.3 billion of converted term or new loans, and I'll expand on that in a second, leaving that original portfolio of C&D of December '07 at a level of $684 million at the end of the day. and I'll address that also.
The next slide does address that $1.3 billion that we've converted to term. Now what does it mean to convert a C&D loan to a term loan? It means that the construction is complete and the certificate of occupancy has been issued. Lease have been stabilized and the occupancy of pro forma loss [ph]. Minimum debt service coverage are typically 1.25 for apartments, 1.3 for office and retail, 1.4 for hotel, have been established for the trailing 12 months. So we know the cash flow is improving. We worked out our portfolio with the following results. And I would refer you to the chart. We paid off $359 million. We charged off $47 million, and that's mere 2.8%, and we're ending with that -- those converted loans, with $863 million today. Of the $863 million, 6% is Special Mention but current and 7% is classified. And of that remaining portfolio, 96% of these loans are current and accruing. The bottom line is that the loans that were converted to term from construction are performing. No "kicking the can down the road or extending and pretending." We just haven't -- we haven't played that game in this institution.
So I told you about the $1.3 billion converted to term. Now let me address that remaining balance of the December '07 C&D, that $684 million on Slide 83. We've done new C&D loans with the same underwriting standards, but with very reduced property value. So our exposure is what I would consider to be conservative. The result is we now have $2.9 billion of C&D portfolio. So we started with $684 million, we made new loans of $1.9 billion, some noise in our statistics of about $235 million of product changes and product co-changes and so forth, and we have an ending balance of $2.9 billion.
So what are the key takeaways from the C&D, commercial C&D? Some improvement in problem loans, reduced concentration, the old vintage is largely gone and we're experiencing cautious growth and conservatively underwritten C&D loans with dramatically reduced values that we're underwriting.
You can see Slide 87, it's really an introduction to our term CRE. The key point here is there is no tsunami coming at us in the term CRE portfolio. And let me go through that with you.
On Slide 88, my eyes are getting worse, the geography we show on the left of the pie chart is based by affiliate. The term CRE loans are most significantly concentrated in our -- in California, Texas, Arizona and Utah. Term CRE or nonowner occupied loans account for approximately 21% of the loans, excluding the FDIC-supported stuff.
Slide 89, again, the same story you've seen before in terms of the classified loan reductions and our loss severity.
Slide 90, in term CRE charge off and nonaccruals continue to decline, broken record.
Now on Slide 91, these slides represent loans greater than $500,000 without the FDIC support. The left chart reflects the debt service coverage analysis and the green bars equal debt service coverage ratio buckets from less than breakeven on the far left, and above breakeven moving to the right. Of those properties with cash flow trouble, in other words, less than the 1.0 coverage, only 2.5% are nonperforming, that's that little red bar on the left hand, the red portion of the left-hand bar. On the right chart, we've displayed the loan-to-value analysis in loan-to-value buckets with the least leveraged properties on the left moving to underwater on the right. The percentage indicated in each bar and reflects each portion of that bar that is on nonaccrual. Please note that only a very small portion of our term CRE is severely underwater, that's the right bar. On average, about 97% of our CRE term portfolio is performing today. 57% of the loans with debt service coverage less than breakeven are supported by guarantors or global cash flows that give us comfort. So the bottom line in this whole portfolio is that we don't see any real torpedoes coming at us from our analysis.
Moving to Slide 92. This is something we haven't presented before, but most real estate lenders today are looking at properties on a debt yield basis. The debt yield is the actual net operating income divided by the loan outstanding, or in plain English, at what percent the cash from the property supports the debt on the property. The green bar represents buckets of debt yield on our term CRE loans. This chart shows that 96% of our term CRE outstanding achieved a debt yield of 6.5% or greater. 6.5% represents a 4.25% interest rate on a 25-year amortization schedule. 12.25% is about 225 basis points over today's 10-year treasury, which provides us some comfort that there is a refinance cushion or refinanceability of the loan [ph].
Moving on to Slide 93. This shows that the portfolio was originally originated throughout the cycle. There have been articles that I've read and conjectured by some rating agency that we made all our loans in October of 2007. We did not make all our loans in October of 2007. We made our loans across a number of years, so we don't have all -- we didn't all our loans to very high values at the peak of the market. And that gives me some comfort of that well diversified portfolio. The complementary chart on 94 shows that our maturities are not a carbon copy of the CMBS market, or as one rating agency might have conjectured that all our loans are coming due at the same time and how are we going to deal with that. They are not coming due in a narrow window. If you recall George's comments last night at dinner, that the CMBS portfolios are coming due all at the same time, our maturities are spread over years. Now how that might affect us is it may depress the values somewhat in those years. We're seeing our bases come to market, but we're not going to have to refinance all of them at the same time and we see this coming.
And also in the bars there, you'll see those white numbers. That represents the average loan size in each of those particular buckets. So we don't have any huge transactions that are becoming due. It's a very granular portfolio.
Moving on to Slide 95. Of those maturities, just in the next 4 years, only a very small percentage are underwater, that red portion in each of those bars. That represents about 9%, $311 million. And our weighted loan-to-values is about 100 -- greater than 100%, 127%.
Let me very quickly now onto what we've done in the organization in partnership with each of our banks. We're really dedicated to establishing an infrastructure, processes, policies and an enduring common credit culture across the footprint to withstand the next economic onslaught from whatever direction it's coming. So what has been introduced to the company and adopted and introduced by each of the affiliates is not focused on this year, and it's not focused on the regulators. It's focused on the long-term growth and what is now a systemically important financial institution. We are stepping up into a population of banks, and we have to compete with those banks and we have to have the infrastructure that is competent to those banks to withstand what is coming down the road and to satisfy regulatory scrutiny.
James Abbott actually asked me to have evidence to you that we have, in fact, people in the organization that are taking a look at our various portfolios and functions and initiatives.
So standing back over here near the food, where they usually stand, I'd like to introduce some of my key staff. Dennis Spencer, if you could stand up. He is the gentleman who is responsible for oversight of our commercial and industrial portfolio. Paul Simmons, same function but for commercial real estate. Jason Brock, same responsibility but for the consumer and small business. Dale Stephens, who is responsible for policy revisions and underwriting quality. And Michael Plaia [ph], Michael, our concentration risk manager. You can see on slide -- so they are in place. They're working and their initiatives are well underway, again, in partnership with all our banks.
You see on 97, the various initiatives that we have introduced and the enhanced corporate oversight, functionally, in originations, account management and analytics. I'm not going to go through all these. You can read the slides at your leisure. I know we're running a little behind time. We're happy to take any questions on these initiatives but just a concentration of the big issue on the last down cycle with a lot of other banks, including our enterprise. We have focused and there is an entire infrastructure policy oversight and board review of that effort. The underwriting standards are now standard across the enterprise, higher quality, more detail and we're seeing significant improvement there. The high risk products are being looked at, at the banks and at corporate. And new volume credit quality is being scrutinized, again, both at the banks and corporate.
We have cleaned up a lot of the efforts in the problem loan management, our trouble debt restructures, impairment, collateral analysis, exception tracking and so forth.
And in the analytics, as you know, we're involved in a stress testing. That has taken a lot of time, a lot of effort and interestingly, although we, banks, may complain about all the stress testing, it really has helped us learn our portfolio better. It has helped us learn what impacts, what -- across that portfolio. And I think as an industry, it's going to help us all. Finally, we have introduced 23 credits systems projects and 6 of those were already completed.
Just a little focus on the concentration. We have a couple of charts here that you can take a look at. We have a formal board-approved credit risk appetite. We have a committee that oversees that at the bank and we report to the board on a regular basis. And we've already established new limits in the major areas where we thought we needed them.
That chart on Slide 101, you see those yellow diamonds. That's where we peaked in the portfolio on our commercial real estate percentage risk-based capital. Our limits are below that. We're not going to go back to the territory that gave us so much pain before. And you can see the various limits that we've set all across the board at the corporate level.
On the next slide, you'll see limits that are established at each of the 9 banks. Draw your attention to the National Bank of Arizona. You can see where we've got a little bit of out of bed there on that first bar. We're well below that. We're managing that 2 ways. Each bank is setting its limits and each of the banks is setting a lot more granular limits than we are at corporate and then we're watching it at the corporate level.
That is a top-down concentration risk process. We're also, in terms of underwriting and managing concentration risk from the bottom up, from the field. We've established a risk hurdle process in commercial real estate, where we will identify in each of our MSA, what product type might be risked because there is overbuilding, rents are falling, or any other number of metrics. And we have that biased MSA. Each of the banks is using it. It's part of our process of approval of loans. It gives everybody an indicator, "Should we be looking at a product type at all in a particular MSA?" And if we are looking at a product type and so the build has other problems, we should be much more conservative in the underwriting and a lot closer scrutiny in doing any deal approval. We're not out of the business, but we're going to just pay a lot closer attention to the business we do in the higher risk areas. So the concentration risk committee will not only see the top-down level limits, but they're going to get the input from the grassroots from each of the offices in terms of managing our portfolios going forward.
So on Slide 104, the key takeaways from credit. Credit quality metric has improved materially, again, in all loan types and geographies. The bad loans coming in are slowing down. The resolutions are favorable to us. The reserve is strong, and we have significant improvement in our problem loans. The C&D risk, which has been a concern, is well managed and under control. We reduced our concentration, and the old vintage is largely cleaned up. Term CRE is diversified, spread across a number of years in origination and no tsunami of maturities coming to hit us. We have process improvements that are promised a year ago to set up. They are in place and operating, and we're already seeing significant improvement in the processing in the underwriting. Concentration management is in place and with a dynamic process going forward. And I think most -- everything that we intended to put in place a year ago is in place and operating.
And with that, James, do we have time for Q&A? Here's the microphone.
James R. Abbott
Oh, I thought you're going to ask a question.
Kenneth E. Peterson
Ken, could you give us a sense of as you look at the mix of the portfolio today, what the inherent loss content of the portfolio will be in a more normal economic environment? How long it will take Zions to get there? And the other side of that question is for the guidepost that we look at clearly of excess reserves today, but what's the mid-floor?
Kenneth E. Peterson
I'm the Chief Credit Officer. There is no such thing as excess reserves. You'll have to talk to James and Doyle. The more reserves, the better. And I'll let the financial engineers...
We follow GAAP accounting very closely.
Kenneth E. Peterson
I derive comfort from the level of reserves that we have now, especially when we look at our peer group. In terms of the inherent losses, I think we have some rebalancing of the portfolio. We still like to perhaps reduce some of our commercial real estate, but again, I think if we underwrite prudently in each of the product types, there are some terrific opportunities. And I think we have the discipline in place to go ahead and make more real estate loans as we see them on a one-by-one basis. We're not managing a certain percentage in commercial real estate, a certain percentage in C&I. I think we're more granular in the credit quality of what we're underwriting and where we're underwriting it.
I will -- I think, Erik, I was talking with you and a couple of the others last night about this. I mean, it does appear to me that we're finally on the way to -- that we, the industry and accounting profession and the Basel and the SEC, are on the way from -- to transitioning from a reserving model that is so-called incurred losses, which is -- you can't look to future economic conditions. You have to look at what's kind of inherent in the portfolio today to an expected loss model, that it includes probability-weighted future economic scenarios. If you think about it, what that will do, even if you ascribe in serving a single best point estimate, it will tend to buy us the reserve a bit higher than the single best point estimate, because you will ascribe some probability to a severely stressed environment and a much higher -- a possibility of much higher losses coming out over the ensuing couple of years. So where that -- how that's going to actually unfold, the implementation, timing or whatnot, I don't know. I think, ultimately, it will lead to an environment in which reserves will never again go to kind of 1% of -- or even less in some cases. But it's not -- even if you think carefully about what I just described, it's not going to make a 3% reserve sustainable in ordinary times. So I think if our credit -- with our credit quality continuing to improve, and we think it is, the loss there is not getting worse. Our reserve is going to continue to come down. That's the best forecast and exactly at what rate -- and when we transition to that new world and where we stabilize to something above 1% but well below 3% of reserves, I don't know. I promised Jennifer next.
Jennifer H. Demba - SunTrust Robinson Humphrey, Inc., Research Division
Could you talk about your approach to early problem loan workout now versus perhaps before you came in to the company and how big the special assets group is today? How large -- how big it's going to stay on an ongoing basis?
Kenneth E. Peterson
Yes. At least 1 or 2 of the banks have already instituted a healthy loan portfolio review on a regular basis. To me, that is the best vehicle by which you start identifying problems early. If you wait until there is a nonpayment or you wait until there is a significant event to look at your portfolio, that's when you get surprised. So I think there's already a culture going that we're going to be looking on a very regular basis at the healthy loan portfolio and talk about it with credit officers, with lenders, with management, to identify early warning problems. This risk hurdle process is part of that, where we are in the commercial real estate area, looking at all the building in a particular market, what's our exposure there. We have a product called PPR, where we can, loan by loan, identify where we are in any given market. When we first looked at it, we were a little surprised to find that Mesa, Arizona that we have, I think 4 banks with real estate products in Mesa. And the 4 banks didn't know that the others were lending in the same marketplace. Now we have that visibility. All of the banks have that visibility. So that management process, I think, is going to be critical to the early identification. In terms of the problem workout, one of the things that we instituted -- actually, a couple of things, we have at corporate now an executive that came out of the workout group that has now coordinated all the policies on foreclosures, on workout policies and ORE management. Those policies are -- have been adopted by all of the banks and the executive, Danny -- David Meeks, is going to be working with each of the banks, special assets group, in evaluating what's going on there, getting early warning show [ph] and best practices. But we have one common policy in that area and going forward. We've also centralized or standardized the oversight for appraisal, cost engineering and environmental so that we -- we're not quite as for long in that effort, but we are going to have a common oversight of our previous policies, what we're doing for environmental inspections, and policies and our engineering. So everybody is making sure that we're hitting the same boxes in that area. So I think that those elements are critical to the early identification, one we identify being able to act quickly in the long run.
Jennifer H. Demba - SunTrust Robinson Humphrey, Inc., Research Division
Can you talk about the pace of decline you expect in your environmental cost and your OREO cost tied into all this as you work through the problem assets that you worked through the foreclosures? Can you give us any idea of what will you think about the change is going to look like?
Kenneth E. Peterson
I don't know if I can give you any specific numbers. I can tell you that the cost went up significantly, obviously. We're having fewer and fewer problems. So that cost is going to come down as the resolutions are getting tougher. The low hanging fruit got taken care of. The problems that remain that had been here a long time are probably be a lot tougher. Although we've taken the mark on the balance sheet, we don't expect to see significant unexpected losses going forward from that portfolio, but I would expect those costs to come down in virtually every one of our branch. You can probably check with each of the CDOs. But I think that's a part of the cycle. I think you'd see that not only in our banks but in our competitors.
James R. Abbott
Okay, one more with Steve Alexopoulos.
Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division
Ken, in terms of the change in oversight process, how much of this is actually you being more involved in the region and underwriting in this credit approval versus you actually removing credit approval from the region and becoming more centralized, like your prior banks?
Kenneth E. Peterson
We're clearly not removing credit approval from any of the regions. The model of this bank is we have independent banks with professionals in each of these markets and that's the strength of this company. What we have done is introduced common policy, common practices, the same way to look at it. We meet from a corporate and reporting -- we're all the same shareholders and we own only one share of stock. We want to make sure there's consistency in each of the banks. We're providing training to make sure that everybody is -- had the opportunity to upgrade their lending expertise. We're trying to get best practices from the banks in how we underwrite a given product type or in a particular marketplace. So it is a standardization, and what we're all seeking to achieve is a common credit culture executed individually by each of the banks, not a centralization of that approval, not an underwriting at the corporate level, although we're looking at the underwriting and giving feedback as to where we can make improvement. But it's still the decentralized model, execution in the marketplace where we can compete very effectively against a Wells Fargo or the smaller banks, but on a common platform executed by the executives in place.
James R. Abbott
Okay. Thank you, Ken. We appreciate it. Ken will be available for some more questions in the future, maybe towards the end if we -- if you have follow-up. But we're going to turn and keep the agenda going with David Hemingway to talk about the CDO portfolio. And so David's coming up. After that, we're going to break for about 20 minutes or so to give you time to grab some lunch and then return here spot and we'll take you through about 6 bank presentations as we go around the affiliates. And then we'll do our breakout sessions after that. Thank you. David?
W. David Hemingway
Thank you. We're going to make sure I know which button to hit here. One of my personal goals is to actually speak at the Biannual Investor Day Conference and not have to talk about CDOs. We're getting close. Last year, I clearly remember -- or not last year, but 2 years ago, I clearly remember speaking to many of you. And we have here at the first page what I've said at that point in time, which, looking back, is absolutely what has taken place.
First, the FDIC had limited resources. And so they actually chose to close the largest banks first, which is what they did and was becoming apparent 2 years ago, that as they move forward, the banks that they were going to close would be smaller and this would have 2 benefits to our portfolio. One, that we'd have less exposure. In other words, many of the smallest banks didn't issue trust preferred. So that we wouldn't have exposure to it. But then, number two, if, in fact, we did have exposure, it would be a smaller amount. I mean, it would be $5 million or $10 million of exposure to the pool of collateral, not $200 million or $250 million of exposure. And that forecast has played out very well.
So to move on to the next page here, significant takeaways, is that in fact, that process is playing out. Now let me remind you that in trust preferreds, if you defer -- in other words, if the bank holding company chooses not to make its payment, you can only do that for 5 years and then there's a limit. At the end of the 5 years, the bank Board of Directors, the bank, even the regulators, have 3 choices. And these are the only 3 choices: They can either come current, which means pay us the back interest. That's one choice. Two, they can sell the bank for whatever they can get for the bank and, of course, the trust preferred holders, being seniors, the common shareholders get paid off first or get to become creditors of the new larger institution. And three, you can file for bankruptcy as the holding company because you defaulted on your debt. I don't actually know many bank holding companies that are operating in bankruptcy. So you really only have 2 choices, either come current or sell the bank.
Now as you'll see here in a minute, we have in our collateral pool that's underlying our CDOs. There's 226 banks that are deferring, or bank holding companies. So when I say bank, I mean bank holding company, which is $2.9 billion of collateral. And as we have looked at that collateral, we know that there's 60 months in 5 years. 30 months has expired. In other words, the average remaining time to the end of the 5 years is 30 months or half the time has passed. So I'm pretty comfortable predicting over the next year or 2, you're going to see -- before you come back next time, I'm pretty comfortable predicting you're going to see 1 or 2 things happen. There's going to be a lot of cash coming into these CDOs from banks making up their back payments, or there's going to be a lot of sales of these 226 banks. And we'll show you some further charts as we go through here as to why I believe that.
The next page, you have this in your book. I mean, basically, this is a chart that comes right out of the news release -- I mean, when we released this information. So this chart should not be unfamiliar to you. Basically, it shows there that we have par amount, current par of $2.6 billion. The amortized cost is $2.1 billion. And the carrying value or the fair value is $1.2 billion, which means there's just less than $1 billion of negative OCI. And that, of course, on a tax-adjusted basis, is going through our capital account, which is what's impacting -- which is negatively impacting our tangible common equity.
I think the other takeaway you should look at here is, to come up with these current fair values, we've given you there what the discount rates that are being used to calculate the present value. You can see there, for the BBBs, it's at LIBOR plus 33%. For the A -- what was originally A, it's LIBOR plus 17%. You all build models. I don't actually have to tell you if you discount some future cash flow at LIBOR plus 33% or LIBOR plus 17%, that gives you a pretty small current value -- current fair value. And therein lies the billion dollars that's been taken out of our capital account.
Now let me remind you that under GAAP accounting, if we think there's a credit loss, that has to be taken and all of that has been taken. The OTTI has gone through. So whenever we determine that there's a credit loss based upon our models, that's already gone through the income statement and the capital account. It's -- the difference is the discount rates that you use to calculate the fair value versus the credit price. Obviously, to calculate the credit price, you use the coupon on the securities. If you calculate the fair value, you use the discount rates that you see here on the page.
Now as we pointed out in the past, I'm going to say here, these are the failures, the failure rates for each quarter. The total there is how many bank holding companies failed. For example, in the fourth quarter of last year, there were 18 bank closures, bank holding closures. I mean, Friday around here is all kind of like Christmas, of a bad Christmas. We all wait around and say, "Okay, who got closed this week?" I guess it's -- the opposite of Christmas.
But anyway, there are 18 banks closed. Saturday is actually Christmas, when they sent out the email, saying none of our banks got closed. That's good. But we had exposures. You can see there's the 3. So I'm going back to what I told you 2 years ago: Our exposure is going to be smaller and smaller.
Now let's talk about the -- our predicted -- I mean, when you look at this, what this is, is a chart of how many banks we predicted would be closed and how many were actually closed.
Now if you look in 2009, we predicted that there would be 63 bank holding companies closed and there were actually, what is it? I can't -- 59, it looks like. In 2010, we said there are going to be 64 closed, and there were 47 closed. And then in 2011, we said there were going to be 54 closed and there were actually 24 closed. And in 2012, we say that we're predicting will be 61 closed, and there's been -- we've had exposure to 2. And this is, of course, not the total closure, but our exposure, which would be 17. Now you're all kind of model builders. You're forecasters. I'm sure you noticed our forecasting is getting worse. I mean, if I were taking a class in forecasting and I had to show you these results, it's a pretty lousy performance. The closures are going down and you're predicting there's going to be more closures. Well, I don't know what you might say but same, to use here first, "We're from the government. We're here to help," or "This is why the Soviet Union didn't work." We're not actually trying, I guess. Well, we thought we were trying to predict closures, but our regulators don't see it that way. They -- every time they come and look at the model, they have ideas as to how to make it more conservative. And so consequently, as you can see here, we're getting more false positives. And they actually like that. They think that's good. So please don't give us a on our forecasting ability based upon the fact that as the closures go down, we're forecasting more closures because it's all the tweaks that have been imposed upon us by those that we have to listen to, but this is the model that's underlying the fair value. This is the model that's underlying the negative OCI. This is the model that's -- and I'm just showing you what the results are, it has been reviewed every year, multiple times by outside consultants, by accountants and by bank regulators.
Now the one thing we're very good at is predicting which banks will fail. And you can see here that those banks that we're closed just last year, basically we have them at 99% probability of closure. Now we have a lot of banks at 99% probability of closures that weren't closed. But certainly, all those who got closed, we had, and you can see the numbers there, basically nailed that they would be banks that would be closed by the FDIC.
An important thing here is to distinguish between performing banks and nonperforming banks, and again -- I'm sorry, about bank -- holding companies. But I think there are 2 things on this chart that are important. One, that the probability of default for the performing private and public banks has actually increased, and we have footnoted there. That's not because their numbers have gotten worse, that's because our friends have made us impose force on underperforming banks because they weren't looking too good. And so, there really is not a deterioration in the balance sheets and income statements of these banks, there's just floors that we have put into the model at their request. Request is a nice way of saying it.
The other thing and I think it's important here is if you look at the deferring banks, the probability of default for the deferring banks, and again the deferring banks are those that are not paying us interest currently within the 5-year period. That's come down from a 45% to a 25%. So the average for the whole portfolio, even though the worst ones will have a probability of 100% or 99% as I just showed you.
So there's a lot of really good banks that are deferring. And if I say, well, "If they're balanced, if they're making money and met all of their standards, why aren't they paying us the interest?" I understand this really well, because they have a regulator there who's telling them, "Well, don't bother to pay." That means there's no penalty to you for not paying. If you're a community bank, you don't have access to the capital markets and your regulator is saying, "Well, let's just watch it a few more quarters. Let's make sure things have really turned around. Let's make sure we don't go into another recession. You're not up to your 5 years yet, you don't have to pay." I mean for any of you that have had this experience, you know what I'm telling is absolutely true. And so we have a lot of banks that are still deferring. As I said, there's 200 north of 26, you'll see it here in a minute.
But keep this in mind, I'm not actually on the right page. Okay. Keep this in mind, the fact that the mathematical probability of default of the deferring banks, I think the important thing is it has come down from 45% to 25%, which means many of those banks are getting better.
Now I'll describe to the next -- as on the next chart here now, the next chart just basically talks about stressing the portfolio. And how many banks would it take to fail, to get to what kind of OTTI, and you have that there. For example, if there were additional 660 banks fail in our universe that we'd have $318 million of OTTI. And in the Zions' stress case, we have $530 million and $172 million of OTTI. And the Zions' base case, you can see there that we wouldn't have any OTTI.
As I need -- I mean just to give you a -- we've had a lot of experience in this area, and I'll just say, 660 might seem like a large number for a stress. I can tell you what's in the Moody's model, because it's important when you think about our own rating and it's important when you think about the ratings that they put on to these bank CDOs. They're assuming, last time I talked to them, still that there'll be 1,200 bank closures in the next 12 months, twice this number. I mean if you wonder how did they get to some of their numbers, that's what's built into their model. The fact that there's not that many troubled banks is irrelevant.
The next chart is a chart you've seen before. We've provided it to you. It shows both the number of banks and then the aggregate collateral, underlying collateral and the deferrals and then the defaults, when they deferred and when they defaulted. But what I'm happy to say is there's now orange there. The orange is the re-performance. In other words, bank holding companies that we're deferring have actually come current. Again, they did it in a number of ways. They either sold or they paid us the back interest and are now current and are performing. And so obviously we're looking for more orange on those pages.
The next page shows -- the next page, the top chart shows the aggregate amount of deferring collateral in dollars. You see it's $2.9 billion. And the bottom chart there is, of course, the number of banks in our portfolio that are deferring that make up the $2.9 billion.
Now the other thing you need to understand here, as I move on to the next chart, is Moody's and S&P both believe and it's in their models that a deferral is a default. So in any -- all of this, if you go to the Moody's and S&P models, they have the $2.9 billion in collateral. But underlining these CDOs, they have as defaulted, with no recovery.
And so it's with that information that I'd go to the next page. I have actually been to the senior people at both Moody's and S&P with a number of our people. We've had a long discussion over this. But there's certain events in your life that you just remember and they're kind of riveted in your memory, and you'll never forget them. I remember in December, when we were at S&P with the senior people that are in charge of rating all CDOs and banks. And we were sitting there, there's a group of us, we're on the other side of the table. For those who haven't -- it's a big's table, for those who haven't been there. And we actually confirmed, and in fact, they believe that within their model was this concept that a deferral was a default.
And so I remember clearly asking, "Well, what are you doing about all the ones that have come current, the re-performance?" And there are some, I just wish I had a picture of it. It was like this blank look on everybody on the committee. What re-performance? I said, "Well are you not aware that at that point in time there have been 40 deferring bank trust deferred that have come current?" And they kind of sheepishly said, "No, we're not aware of that."
I said, "Well, I would like to help you out." They said, "Could you provide us with the information?" We said, "We would be happy to provide you with the information." I mean that's the kind of issue that we're dealing with.
I mean what I'm happy about as you see the ladder lines are higher. I mean there's been more re-performance, and what I'm telling you is based upon the fact that the 5 years is running out, there's going to be more re-performances before you come back next time.
The next chart is, so what happens if things get better? And Doyle has kind of introduced this, so I'll kind of skip through this quickly, is one of the things that happens is prepayments have a big impact here. And what you've got on this chart here is actually prepayments caused us to have more OTTI. But the other side of that is prepayments caused the OCI to -- the negative OCI to be reduced.
So let me give you the extreme case, and then you can work backwards from there. I mean we've obviously modeled all of this. If every single one of the underlying trust preferreds adjusted for the probability of default, in other words, if something has a 100% probability of default it doesn't pay off, but if every single underlying trust preferred paid off tomorrow, again, adjusted for the probabilities of default.
The bad news is we would have $130 million approximately of OTTI. And you say, "Well why is that, if they all pay off?" And it comes from the lower tranches because the lower tranches are depending upon the negative -- the positive arbitrage. In other words, the rate on the loans, on the securities that are on the asset side of the CDOs is higher than what they're paying out. So over time, they depend on that positive arbitrage.
So the bad news is, is we would have $130 million of negative OCI, if they all paid off tomorrow, again adjusted OTTI, thank you, OTTI, if they paid off tomorrow.
Now what's not here is the positive news. If they all paid off tomorrow, we actually wrote down many of these securities when we bought them out of Lockhart and put them on our balance sheet. And the positive news, we'd have $130 million approximately of the gains on securities. I just coincidentally -- I guarantee, coincidentally offset each other, may have happened. they'll be happy to take the OTTI, and we'll be happy to take the gain.
So I want you to understand that as these things prepay, there are 2 things going on, the senior tranches would actually be taking gains like we did in the third quarter. You may remember, there's $13 million of securities gained in the third quarter that was from prepayments. And then there was negative OTTI, which comes from prepayments on the lower tranches.
Well I don't think they're all paying off tomorrow, but I do think there's going to be prepayments. And in fact, you can see here that if you get prepayments, that in fact the negative OCI is reduced. In other words, there's less negative OCI and you got the chart here to see it.
Now the discount spreads will change because you'll shorten the average lives. But the other thing that will change is -- I happen to think that at some point, you just have to be patient for something, but at some point, Moody's and S&P are going to have to decide that a deferral is not a default, and that's the major problem. And maybe it's just when the deferrals finally correct themselves, they will not be -- it will become clear over the next few years that a deferral is not a default. And even if they don't change their models, they will have to change their ratings.
I have one -- we have security in the portfolio that was $120 million. It's a senior tranche. It was AAA to start with. It's paid down to $26 million. So it's paid off, what, $94 million has been paid off at par. Today, it's rated B by S&P.
Now the reason we have to use these high discount rates is -- the large part because of the terrible ratings that have been placed upon this by Moody's and S&P. The reason they have such terrible ratings is because they've got bad data in their models like, for example, what I've just shown you, that a deferral is a default. And it can be corrected. One of 2 ways, they can either correct their models. I'm not saying over the next 30 months, it will correct itself. When in fact, these banks either sell themselves or come current, and then the models will correct themselves. That in fact will allow the marketplace to decide the discount rates shouldn't be LIBOR plus 17% or shouldn't be LIBOR plus 33%, or anything like that. And that solves the negative OCI problem. And you can see there that if in fact the LIBOR was reduced to -- if LIBOR is reduced to plus 7% or plus 9% what the impact would be -- not the average, what the impact would be.
And then you've got the calculation on the next page as to what it does to capital and to TCE.
So with that, I'll conclude with -- and then we take the questions. I'll conclude with this year's forecast, my forecast, which has not been helped by the government. But in fact, the process is going to continue. The banks are either going to sell themselves or they're going to become current. And in fact that this will correct the models, if they're not corrected before that. That the ratings will improve and that the discount rates will come down and that our negative OCI will become less negative, which of course improves our TCE numbers and it will -- a bit more patience, and we appreciate that your patient is up to this point.
Are there any questions?
If I can just mention, Erik asked a question between -- about the TRS, which I didn't give much of an answer to. Back on, I think it's Page 63 over there. But I did have -- one of the improvements was $13 million after tax per year, if we cancel the TRS. You can get an idea from what David just said about why that might be something we would consider at a future point. The high-risk ratings of the securities are driven predominantly by these ratings and we think the ratings are garbage. So we're paying to undo the negative impact of clearly bogus ratings by the rating agencies. If they begin to get, we think, more realistic about this and/or they proposed regulations to remove the use of ratings as the driving force in risk weightings of assets later this year are implemented, we will then consider kind of under either or both of those scenarios, whether it make sense to continue the TRS any further.
All right, can you please clarify your basic expectations for your OTTI? Because I'm thinking...
W. David Hemingway
Your OTTI. Because on Page 113, it says you're base case is 0, if you have 290 bank failures. But then you talked about if -- as you continue to get these payoffs, you're going to experience OTTI on the line tranches or the yellow or A tranches. I'm just trying to -- what -- if you could pick a number, what should we be building into our models? It's probably more than 0.
W. David Hemingway
Well if you tell me what the CPR is, I'll tell you what it is. It is CPR dependent. I mean the faster the prepayments -- I mean the faster the prepayments, the more the gains will be at the top. I mean I think I actually think the third quarter was really instructive where we had $13 million of security gains, which came from prepayments and we had approximately $12 million or $13 million of negative OTTI, and they basically came from prepayments. We kind of have a tolerance range around here, maybe plus or minus $10 million because we just don't know. I mean the answer is we don't know.
Basically what's in our -- in effort, we have modeled a specific pattern of future bank failures, David showed you. It's 61 failures total this year, which we would have exposure to, I think, at '17 or '18. There are future failures in all those years, and we have modeled a constant prepayment rate of 3% basically on the performing banks. If that scenario unfolds, we will have no additional OTTI. That's it. That's -- but it has to be precisely that scenario. If there are fewer failures, that won't necessarily mean negative OTTI. Although there may come a point, given how vastly we have overpredicted failures in the past and taken OTTI on it, that we might even have to accrete some of that back, we're not there yet. But I think the key is, it's likely that there won't be very much more OTTI, if any, because of bank failures. But there may be OTTI if things get better faster and prepayment speeds pick up to more than 3%. 3% is what we have observed over the last couple of quarters or so.
W. David Hemingway
And there's another thing that impacts OTTI, just to at least explain why it's so hard to predict or even have an idea is -- a good part of the OTTI this past year came from the regulators requiring us to change the model. I mean I mentioned the floors that we've put in as a request. Well everything they request has the impact of creating OTTI. I mean I can't think of anything they've asked us to change that didn't actually create some OTTI. Now it didn't create near as much OTTI as they were expecting. So I mean the other variable here is I have no idea what the Fed or the OCC are going to request on the next exam as far as changes to the model. But I know that their practice has been to try to trim up, some way to change the model, which I've just shown you, makes it less predictive, but does in fact, generate more OTTI.
James R. Abbott
Other questions on the CDO portfolio?
Doyle L. Arnold
As a follow-up comment to David. As CFO, I have to sign financial statements under GAAP. My tolerance for arbitrarily increases on the conservatism of the models and still being able to sign financials, there's about it that's end, unless there's a very valid reason. So I'm just saying what David said, I wouldn't expect much more negative OTTI to be caused by our agreement to change assumptions in our model in the absence of demonstrable evidence that, that's appropriate.
I just wanted to ask if the rating agencies have adopted your view that deferrals are not default? And what's your best guess how that could change the risk ratings on the CDOs?
W. David Hemingway
Well what it would do is particularly at the top of the pile -- there's one security I have that I just mentioned to you. It's paid down from $120 million to $26 million and has a B rating. Well that's a classified asset. That's one of our classified assets. The fact is at the top of the pile, I'm trying to give you some color, it doesn't actually impact it that much. It would have because it's already -- I mean we're not using the ratings for the risk weighting. So it was impacted further down. I mean what was AAA, what secondary tranches or what -- for example, what would really help is insurance. I mean if you haven't thought about this, how many insurance companies have been closed? I mean not very many. And in fact if you want to look at a CDO class that is performing just as it was proposed to perform, it’s the insurance CDO. And we've got the insurance tranches that were A-rated, that had never missed a payment, they've never had OTTI, I mean they're underneath deferrals or defaults in the collateral. But we're having -- they've been downgraded just because the rating agencies went through and downgraded everything. So we're keeping a solid per dollar capital because of the ratings. I mean if they would put -- I mean if they look at anything, put a BBB on it rather than a CCC, the capital would go through -- down 1/10 of what we're currently seeking, as kind of an example. I don't have an overall answer for the whole portfolio. But it could be very dramatic. And if we have that, it would help us do what Doyle suggested, we could stop paying for the TRS because mainly what the TRS is providing to us is rewrapping these securities that have such horrible ratings that we're having to keep extra capital, and they're also classified assets in the TRS that we sold, both of those issues.
One of the additional themes. Just so you can understand from the model that's driving the ratings, on Moody's, what they -- they actually run every bank, just like we do to a probability of a default model which is based on all the collar put [ph] data. And then once the probability default comes out of that, then they also add to a probability, additional probability of default based on the taxes ratio. And then whatever the answer is that comes out of that, then they multiply that whole answer by 1.25 because of uncertainty, I guess. And so it's that kind of conservatism for garbage, depending on your view, that gets you to these really core ratings and really high risk weighting.
W. David Hemingway
And high discount rates in the market. I mean you know there are lot more buyers, who can buy something with the BBB, even the BB and the C or a CCC. I mean where liquidity comes back to the market is when we at least put something that's in the ballpark on it, and there will be buyers. But if we want to go to the Canadian take, I got this great deal. I've got an insurance CDO that was A-rated that has never missed -- there are no deferrals and no defaults, but it's got a CCC rating, how do you feel about that? There's just not any buyers?
James R. Abbott
One more question in the back, and then we'll break for lunch.
David to your -- going back to your opening point there of dreaming of someday not having to speak about this topic at one of your Investor Days. You talked like you're accounting, being more comfortable around it, you talked about the challenges of dealing with the rating agencies. Can you talk a little bit, if you can, about for the regulator stand on this portfolio within the risk framework of the entire company? And what, if any scenarios, would there be for you to decide to derisk it, get rid of some of it, try to alleviate that quicker, so in 2014 when we're here, it's not on the table?
W. David Hemingway
Let me first ask the question with a question, and then I'll add. So if you were the portfolio manager and you had securities that you'd spent thousands of dollars modeling, you've had your model reviewed by a major name management company and they said it's the most robust model we've seen as far as granularity. But instead of writing, they said it didn't -- don't have to take my word for it, it's hearsay, and I won't tell you who it was, but it's someone the Fed uses. So if you'd had your model reviewed and your model showed that you're going to get $0.100 cents on $1 if you hold on to this security. If you're going to sell that security in the marketplace, you'd be lucky to get $0.10 on $1, how motivated would you as a shareholder be to go sell those securities? Would it not motivate you to take a little bit more grief from somebody that knows a fraction about it, of what you know. Now I mean that's kind of my position. How many of these securities that I knew I'd get $0.100 on $1 do I want to sell at $0.05 or $0.10 if can find a buyer. I don't think that's in the best interest of the shareholders. Fortunately, I think the regulators have, I'll say this, are impressed with the amount of work, and we have several PhDs working on this and the model that we've built and the effort we've put into it. Now we actually have had discussions about some different options, which I probably won't discuss here. But I would hope that in some way that the shareholders actually are not the ones who lose out here in the end, that we've come this far, it would be able to deliver those returns and not just pass them onto somebody else who's willing to look at the numbers and not just get panicked by the fact of all that.
James R. Abbott
Maybe 2 more questions. And then we'll...
W. David Hemingway
Given the return you're looking at, one of the disconnects could be, as banks fail, we could see the same development that we had with the recent bank selling that's now being contested by our preferred investors. [indiscernible] by guaranteeing you that we're going to contest, and we've just won. And so your view of the contract is that preferreds do have the ability to block that out. And we have actually worked with the other people who own this and we have a lot -- I mean in the bank alignment case, you can see that the judge ruled in our favor, and I think that deal will get recapped.
Just following up on Ken's question. As the market gets better, and your analysis should have proven true. Will the upgrade come to be at the start of sell selectively? some of these TruPS to selected buyers who might be interested in buying this debt?
W. David Hemingway
There's nobody who would like to sell this portfolio in this room more than me. I tell that to regulators. I'd love to sell this portfolio. It'd make my life easy. Yes, I do have some -- I mean I have a lot of commitment to the shareholders of this company. And if I thought that there was a reasonable price, even if we had to take a 10-point discount, I'd be thrilled to relieve the company of this and just move on. My problem is taking a 90% discount off in something that's -- I think the values is there. So I think it's like a lot of this, you'll have -- management will have to make that decision. I'd be thrilled to sell off $1 billion, but I'm not for $0.05 on the dollar.
Our ability or intent to hold the maturity at this point in time?
W. David Hemingway
Yes, that's right.
Just for the record, Doyle has said, we have not.
Doyle L. Arnold
What I said is if people are really willing to, but our intent is to hold on. Actually, what we have the intent to is to hold them until they recover their value. That's the rules for available-for-sale and yes, we have not changed that.
James R. Abbott
Okay. We're going to pause this presentation. For those of you on the Internet, probably just keep monitoring. We'll probably be away for about half an hour. As we take a break, we got lunch, and we will be back and we will restart at that point, which would be, let's say, it'll be 2 p.m. Eastern Time or noon Mountain Time when we restart. Thank you.
James R. Abbott
If I can grab everybody's attention. Okay, thank you for joining. I'm going to take you back to one slide. It's Slide 49, which is the earnings scenario summary. And remember, this is an illustrative example, it's not a forecast. But we do have a correction. And if anybody else finds another correction, we have Snickers candy bars that we will be happy to deliver to you with the 200 and somewhat 30 page PowerPoint presentation, there's probably something that we haven't done.
On this page, if you add up the first 3 numbers, it doesn't add to 467. I tell you what the reality is that we originally had a little bit lower cost of debt when we made these assumptions before and we try to make them even more conservative. If you actually think about the cost of debt or the cost of issuing preferred stock at LIBOR plus 6% or 7% 100 basis points. It's so pretty wide, so we think it's conservative.
So that's the difference, it adds up to 439, the ROE number is unchanged, we actually got that part right. So just wanted to make -- bring that to your attention.
Okay. So we're going to move on -- we've actually had a suggestion from the Nevada, Arizona guys, which is a good suggestion, I think. And that is to let them do their presentations in the breakout sessions. The bottom line, I think you'll hear from them is that things are improving. But we're going to let them take their presentations to the breakout session, so they can have a little bit more time to go through it there and talk to you about that.
For those of you on the webcast, we still have the presentation there, and you can read through quite a bit about it. We're going to a break. To go to the breakout sessions at 12:45 Mountain Time or 2:45 Eastern Time. So we're going to do a 45-minute, and try to go through the biggest 3 of the banks plus the energy portfolio in 45 minutes.
So it's a full task, but we're going to turn this time over at this point. And so the first of this presentation, Scott Anderson from Zions Bank here in Utah and Idaho. Thanks, Scott.
Aldon Scott Anderson
Well, thank you. To give you a brief summary before I go through these slides, the Zions Bank in Utah and Idaho, has seen significant improvement in the credit trends. We were profitable for every month last year. The pipelines are growing and increasing and our economy is improving.
And so with that, if you turn to the first slide on the Utah economy, the best news is our legislature is in session right now, and they are looking to create a budget for fiscal 2013. And they are looking at a surplus of about $400 million, so they'll get the final numbers next week. We expect it to be higher that at least the revenue has come in much stronger than they anticipated. Based on that range #3 in the country in terms of economic growth just trailing North Dakota and Oklahoma. We've created about 35,000 new jobs over the trailing 12-month period and we've seen significant growth in 5 of the major employment sectors. Home sales have gone up last year. Inventory is down. Prices are down somewhat compared to 2010, but foreclosures are down 32%.
Utah has been ranked by Forbes Magazine as the best state to do business for the last 2 years and the economy looks good. And in fact, people have confidence. In fact, Intermountain Healthcare, which has -- does about 60% of the healthcare in Utah announced that there were 31,000 births out of their hospitals last year, which they take as a sign that people have confidence in the economy in going forward. As you look at Idaho, Idaho unemployment rate is at 8.4. Inventory levels in the Boise, Ada County area are down 31%. The current inventory supply is about 4.4 months compared to 8 months last year. Foreclosures are down 40% and Idaho is also looking and rank a 10 nationally in terms of the economic climate.
So on the next slide, you'll see some of the key factors. The peak area is the highest that it has been over the last decade. So the unemployment at the peak in Utah was 1.3 million. It's currently 1.26 million. The unemployment rate is 6%, where at its height, the unemployment was 8%. Retail sales, the largest growth year-over-year, was 12% over the last decade from 2010 to 2011. It was up almost 5%. Housing starts last year were 8,700, and you can see the same growths for Idaho.
If you look at revenue for the bank, revenue is growing. Total revenue is up 8% over 2010. You'll note that net interest income is down about 3%, while non-interest income is up significantly and that's largely due to gains in securities. In 2009, you'll see that we had a negative non-interest income figure, that was due when we were bringing securities over from Lockhart, and as we wrote them down, to market. As you look at the pretax core earnings, you'll see that we, end-of-the-year, was with about $207 million net income after tax, and provisions, was about $150 million. If you adjust that pretax, pre-provisions and pre-OREO and credit expenses, we came in last year at almost $400 million, $398 million.
As you look at the credit quality trends, you'll see that charge-offs are down significantly from the prior year. We ended 2011 at about $180 million in charge-offs compared to $321 million the year before. And you can see the reductions in almost all of the categories. Nonaccruals are also down almost 50%, 47% from $471 million to $250 million.
If you look at the classified assets, you'll see that they are also down significantly, about 21% when you include both the classified loans and the classified securities. The securities are down 18%, while the loans are down 30% and OREO was down 60%. As you look at the classified/Tier 1 capital plus reserves, we went from 75% to 51% including securities. And looking only at loans, we went from 50% to 32%. It's interesting to note that if you look at the criticized portfolio, including classified and special mention, about 75% of them are paying as agreed and only 24%, 24.6% are delinquent.
We've learned a lot during this -- these -- or let me -- before we go there, if you look at core lending growth, we have an interesting portfolio in that we have some portfolios that we have moved out of the area like dealer finance and we are letting that liquidate. We have put constraints, as Ken said, on our national real estate lending as we put concentration limits there, both on a geographic basis and a product basis. And so last year, the national real estate portfolio shrunk almost $400 million, $396 million, while the liquidating portfolios went down $113 million. The core lending portfolios, C&I, commercial real estate and consumer, actually went up $387 million. And if you look at the swing between 2010 to 2011, it's almost $1 billion swing and that 2010 over 2009, the portfolio had shrunk in that core lending area about $574 million. So the core growth is there, the pipelines are strong and we have about $1.1 billion in the pipeline and we convert about 30% each month. So we are pleased with that growth.
We've learned a lot during this cycle. We need to be more disciplined with concentrations of credit. We need to look at a diversification of revenue including an increase in non-interest income. And we want to make sure that our underwriting looks at all of the aspects in the market. But we did a lot of things right during this cycle. We really focused on relationship banking. And that has paid dividends, not only in continuing to do business and keeping good clients with us, but also in handling some of the problem credits that we ran into. Our credit management area and special assets area, they were very aggressive in intervention and disposition of problem credits, as you can see. And we try to manage the reputation of the bank in our market, which again helped us significantly as we work through some of these problems and continue to do business.
This year, 2012, we're focusing on revenue growth. We're focusing on loan growth. We're also focusing on expenses, as you'd expect and the management of risk. And you can see some of the points there of what we're trying to do.
And so if you look at some of the key operating comparisons, you'll see that salaries compared to 2007 are about flat. FTE is down about 200. Some of that is the transfer of FTE from Zion's Bank to the holding company. You'll see that we've seen some decreases in net occupancy expense. We have moved out of our in-store branches that we had in the Smith's stores. We are closing the final 2 that we have in the Smith's stores this quarter. And then, we've seen some good reductions in legal and professional and in the supply area.
As was mentioned in earlier presentations, we see some significant expense opportunities in FDIC premiums, in OREO expenses and in credit-related expenses. We expect OREO expenses to be down about $16 million and credit-related expenses to be down another $4 million, and that will help us as we move on.
Zion has received some nice awards and recognitions. The Best of State, one of our women were placed in the top 25 most powerful women in banking, and we participated in the women team of bankers that Harris mentioned that was recognized. We are the top SBA lender in Utah for the last 18 years and the top SBA lender, 7(a) lender in Idaho for the last 10 years. And we're the largest producer of 504 loans in the country. So we are doing a lot of small business lending and we continue to pursue that. And as mentioned earlier, Greenwich has recognized our ability to do small business lending and middle market lending, and then as Harris mentioned, the reputation that was -- our reputation that was the second best in the country. So with that, the bank is doing well. It's well capitalized. It has liquidity and the future looks good. Thank you.
James R. Abbott
Thank you, Scott. Next, we'll have Scott McLean and Steve Stephens who will come up to present on the Amegy portfolio -- or the Texas presentation plus the Amegy portfolio.
Scott J. McLean
Great. Thank you all. I'll start off here on Amegy and share that with Steve and then I'll come back and give you a little bit of overview of our energy exposure. First of all as you, I guess, our slides are -- here we go. I think most of you all know that the Texas economy is very robust, very strong right now. And it's a great environment to work in. Houston clearly is the strongest economy in Texas. And you look at jobs, population, almost any demographic for the state of Texas is bigger than 2/3, 3/4 of the states in the United States. And arguably, year in year out, Texas is one of the 10 largest economies in the world just by itself. So it's a big place and a really good place to do business. About 85% of our revenues are centered in Houston, the other 15% are in the start-up operations we have in Dallas and San Antonio.
If you look at the Houston economy where we're the primarily located, if we advance the slide here, can we advance it to the next page, here we go, clearly, energy is the key but the economy is much more broadly diversified today than it was in the 1980s. The Texas Medical Center, just as an example, is the largest medical center in the world by a factor of 2 and there's about 33 million square feet of office space, and the Texas Medical Center is bigger than Chicago Inner Loop. It's bigger than downtown Cleveland. It's a large, very vibrant part of our economy. Most people don't talk about ports. They're not very effective [ph] things, but in our case, it's a big part of our economy. And it's the largest port in the U.S. in foreign tonnage and the second largest in terms of total tonnage in the Panama Canal opening up in 2014. It'll just simply become increasingly more vibrant in our part of the country.
Could you advance the slide again? We'll look at sort of our financial results over this period of time and one of the things I want you to sort of think about for just a minute is in September of 2008, Houston was hit by a Category 1 hurricane. It was a direct hit. Most people in Houston, 6 million folks in our city were without electricity for at least a week and many for 2 weeks. It was a significant issue. At the same time, the financial meltdown was happening around the world. The price of oil was about $140 in May of 2008. It was dropping rapidly to -- and ultimately bottomed out at $40 in May of 2009. And so needless to say, Texas fully entered the downturn that most of the rest of the company had been in '07 and '08 towards the end of 2008. Despite the declining rate environment, despite urban -- our goal really was, in 2008 and early 2009, to maintain our revenue levels and our core earnings during this downturn that we could see coming and that's exactly what you did -- and that's exactly what we did and you can see that we've maintained our revenue right around of $525 million, $530 million during this period, with about during -- depending on which year you look, $1 billion to $1.5 billion left in loans, and core earnings dropped about 7% or 8% during 2009. Our pretax, pre-provision has been very consistent right around $220 million during that period of time.
If we look at the next slide, clearly, we -- the 2009 period with everything that was going on, created a significant increase in classified and nonperformings but now, we're in the third. We got a rapid decrease. We're now at 1/3 of the peak levels in classified and nonperformings, and almost any question about our classified and nonperformers, the answer is that 75% of the problem was real estate. It was commercial real estate. So what percentage of your classified is real estate, what percentage of NPA is real estate, what percentage of charge-offs is real estate, 75% were real estate. And as the largest construction lender in Houston, we did what was normal with construction lending. We generally advanced on land 6 to 9 months in advance of construction at the acquisition phase, followed by the development phase. But when the music stopped, there's no development and it just looks like land. And so we went into the downturn with about $900 million of land A and B that created a lot of our problems.
If you look at the next slide, you'll see that our classified ratio has declined very significantly and we anticipate it'll continue to go down this year. So when you just sort of think about credit quality in Texas, moving to the next slide, there's a lot of data here but we always thought our loss content would be better than most. We thought it would be manageable. In fact, it was, and this is nothing that popped up about but loss content was far worse in many other places.
If you kind of turn to the next slide, what have we learned during the cycle? Without question, it was pretty simple concentration management. We just got way over extended in land acquisition and development lending. The other thing that we didn't need to learn, again, without market lending, we all learned that in the '80s. It's something we definitely knew and this time we did a little differently. We talked ourselves into the fact that we were highly concentrated in Houston and we thought some geographic diversity would be a good thing. It was not a logical thought, and then we thought, "What if we're going to do that? Then let's go to other geographies with people that we know as opposed to going to other geographies with people that we never met before in those geographies." That didn't work out real well because we found out that our good friends, when we banked in Houston, didn't really know these other geographies any better than we did. So we went to these other markets with people that we knew in every case that their experience in those markets turned out to be not enough to move us through that process.
So those were the 2 largest things we learned during the cycle and I'll turn it over here to Steve to talk.
Steve D. Stephens
Thanks, Scott. We'll spend a minute about what we did right in this cycle. I think to fully appreciate that, you have to realize that the previous 18 years started in 2008. Every year, we've grown only part of that loan growth, profit growth. So we always run about 80% office [indiscernible]. So when -- later part of 2008 came along, we realized we had to kind of develop our defensive muscles and to try to balance the defense with the offensive side. So it's got an issue about trying to maintain core earnings while building a team to help through our problems, to try to build a kind of a credit structure. It took some balancing and that's really what we're, I guess, most proud of this. While we built this infrastructure, we kept our [indiscernible] on the street looking for opportunities. We still kind of believe the economy so we maintained that kind of core revenue growth. We have an active calling program. We're always [indiscernible] source of our loans for at least a couple of years that maintained our margins and cross-selling demand discipline.
I think the other part is every link has a culture. We have a very strong one. Parts of that we need to modify in terms of bouncing the credit administration with the sales. The other part that really, I think, has been growth for us is really being out in the marketplace and an open communication with our clients because they were [indiscernible] what we were as a bank and kind of daunting [indiscernible] that it was kind of a good time for the people to kind of take a shot at us. So we were out there very visible and make a lot of calls. But also with our employees who [indiscernible] our employees show that they really work financially. And so I think that helped to kind of galvanize our culture. Also, the main goal was to try to grow loans and what we were pushing to have a good market to also kind of reposition the mix of the loans. We thought we accomplished that.
This slide shows the good balance between C&I loans, energy. Also, we had good energy markets. They got to kind of manage the growth in that area. The balance of that would be others, which we're able to do that. And consumer really -- consumer has never been really a big part of our bank. They've been predominantly a commercial bank. So a lot of opportunity to grow that. So most of these were actually mortgage loans. And then, of course, we're contracting commercial real estate. So all in, we're still able to grow $435 million in loans last year and still got a good backlog going into the new year.
The other opportunity is with the income. We have a fairly good fee income percentage at 27%, but there are a lot more we think that we can do. Factoring has done a little bit [indiscernible] part of bank. It's [indiscernible] very well for us in good cycles but certainly in the [indiscernible] take a lot of the good commercial clients. I'd call it "put them in a hospital for a while and still lend the money in kind of safe structure." We actually have had no losses in factoring, knock on wood, in 5 years. It's been really amazing with the return of that 4% all in on that portfolio. I mentioned we don't have really much in terms of retail. So for example, I think, of all the affiliates, we'd probably have the lowest saturation of credit cards. So a lot of opportunity to out there with retail products doing that.
The residential mortgage side of our bank, we totally reorganized our mortgage group and working them through at the corporate niche, the mortgages. They actually increased our mortgage loans, at which niche totaled $100 million this past year in a good market.
Foreign exchange and all the others go all in. In fact, we've got an opportunity to add about $40 million more to what was $100 million in the prior year on the income.
All this expense control, given the fact that revenues were flat, we've kept our expenses flat. We told about really kind of credit expenses. We still have some opportunity to grow and reduce those down by $21 million run rate on expenses from what was the lowest, $7.5 million. So this [indiscernible] we can improve on that.
And I guess, to close just kind of the opportunity for us. We really started with a very small bank from late 1989, grew up to 2,000 employees, $12 billion assets. So really feel kind of a lot of market opportunity for us. It's only 5% of market share. The big banks have 62% of the market. So we still keep digging at the larger banks. We hit a milestone here recently during this really -- in the last report. We were able to get the lead relationship position as a bank in the Houston market. We grew 200 basis points in our market position. Chase lost a couple of hundred basis points, so now we actually enjoy the top position with middle markets. SBA lending, we actually had lessons from Scott [indiscernible] SBA lending very well. We've been kind of a moderate SBA lender. So to go to the third largest in the market was an accomplishment for us.
One thing we really haven't promoted all that much was our Ex-Im bank approval. Our international group has done a great job in Ex-Im bank financing. We have a lot of clients being close to the court that does a lot of international sales, also a lot of project finance and with the Ex-Im banking get 90% revenue here [indiscernible] is really pretty positive.
I've mentioned about our mortgage production even better upside going forward and then the diversified portfolio of all of our loans and then lastly, the fee income potential that we got. So we really have a lot of optimism going for 2012. And again, we're very fortunate to be in a great market for Texas. So any questions?
We'll do those during the breakout session. James, do you want me to go ahead and talk about our energy? All right, we'll do that. Hopefully, we'll bring -- I think this is the next set of slide in your deck and energy banking industry. Energy lending has been something we've been doing since the mid-1990s. We did it successfully for many years until finally, we had our first charge-off in our energy portfolio in 2008. We have a very deep staff, a large staff on the energy side, both reserve-based lending and oil field service that has been together for many years. And our executive team at the bank, each averaged of -- over 30-plus years of being involved with credit underwriting in the energy space.
As you can see here, we were pretty evenly mixed between upstream, which is reserve-based lending although we're lending specifically against oil and gas reserves and what we call services, which are all the industry that provides service to the upstream and midstream principally. And then our midstream business is generally financing pipeline distribution companies. We really don't do hardly anything in the downstream. We took this picture of the energy cycle in the bottom right-hand corner and to just remind you of sort of generally what upstream, midstream and downstream are.
I want to orient you just for a minute to 2 slides that will kind of give you a sense of major indicators for the oil and gas industry. This is not rocket science. But in this slide, you'll see the price of oil in yellow or gold charted against the left axis, the price of gas in green charted against the right axis. And really 2 things I want to point out. First, looking in May of 2008, which I referenced earlier, it's the peak there. May of 2008, you'll see the price of oil peaked out at about $140. And by May of '09, in 12 months, it was moved all the way to $40. Gas moved similarly. The rig count, which you'll see in a minute, dropped significantly as well. And so by almost anybody's imagination, that was certainly a shock scenario and it was one of the things that had a big impact on energy in late 2008, early '09, which I described earlier.
The other thing I'd like to point out is in the more recent period, really 2011 -- all of 2011, you'll see a break in sort of the traditional relationship between the price of gas and the price of oil. And that's largely because of the significant amount of gas that's been found in the United States and the amount of drilling that's been going on for gas. You can see that also in the next slide. This slide is the rig count. The gold level is the rig for the drilling for oil, the green are the rigs drilling for gas. And what you see historically is that 75% of the drilling that takes place in our country is gas oriented. 25% is oil. That is shifted in the last 12 months. So we're now about 60% of the rigs that are drilling. 60% of the 2,000 rigs that are drilling are drilling for oil and 40% of drilling for gas. Again, that's a function of the fact that gas prices have come down so significantly. And I do want to point out also that May '08, peak of 2,000 rigs dropped all the way to 800 rigs, 800 plus or minus in May of '09, again having a big impact on the Texas economy which we referenced a few moments ago. So with that as a backdrop we've done during this period, as you can imagine, 2009 was our -- sort of our peak worst year as it's related to our energy services and our reserve-based portfolio starting with the services side, the top half of this chart.
Basically, we had -- we have grading risk in our energy services portfolio but the very manageable non-performing risk and almost no charge-offs. We have 1 charge-off in this portfolio of $4 million, 1 charge-off, and we anticipate recovering 100% of that this year. So the energy services portfolio came through this downturn very nicely. One of the things that certainly helped was that it was more of a V as a downturn as opposed to a U.
On that a reserve-based lending side and midstream, we had last grading risk. Nonperformings were very manageable, and our charge-off level was higher than we would have anticipated. And as we've gone back and looked at that, we basically had a handful of credits that we made bad management decisions on. And it was a combination of bad management decisions and decisions about the quality of the management of those companies and the decisions those management teams made to aggressively pursue drilling activity but ultimately was unsuccessful at the time when oil and gas prices were plummeting downward. So we got caught in a couple of places that resulted in about $31 million in charge-offs in our reserve-based portfolio over a period of 4 years, which, yes, is a lot of money and a lot more money than we would have liked to have lost in that portfolio. But it's about 60 basis points that lost over that period of time is pretty manageable compared to most portfolios.
Let me just give you a little bit of drawdown on energy services and our reserve bank portfolio. First of all, this is energy services. It's about $2.1 billion in commitment. What you would really want to know is, do we financing rigs? We really do not finance drilling rigs. We never have and never will. We don't really finance seismic companies. That's out on the sort of lunatic fringe [ph] of oil field services financing. Most of the companies that we finance have very strong private equity backing. The private equity firms have been very active in oil field service for many years now and they did great. In 2009 and 2010, they stepped up in almost every case and did the right thing when the industry was facing the challenges they faced in 2009. So there's certainly a lot of volatility in energy services lending. You need to know that you're doing. We don't do a lot of long-term financing. Most of the term financing we do is on a 3- to 4-year amortization with cash flow recapture. And this has been an industry sector that has worked well for us for many years and should continue to work well because the complexity of drilling is so much greater today than it was 10 years ago, but the need for all these services is more significant per well drilled.
Let's take a look at the reserve-based side for just a minute. This is just -- this will kind of give you a sense of why reserve-based lending has been such a safe place to play over the years. The loss content has been low, generally speaking, throughout the industry. And the basic answer is there is cash flow lending with very significant discounting. And so let me walk you through what that means. So a client here, client is just a mythical client, provides us with $100 million of property that are based on NYMEX, which is the common indicator for oil or gas, all discounted at a 10% discount rate. Okay, so they give us $100 million. We look at it, we study it, we generally disallow about 10% to 20% as the properties they give us for a wide variety of reasons. And so that cuts us down to, in this example, we said $85 million. We then apply to that risk-adjusted portfolio our price deck, which is usually 70% to 80% of NYMEX on oil and about 90% to 100% of NYMEX on gas. And so there's more discounting there, and then we loan, as you can see, 60% to 75% against that depending on hedging that the company has. And when you look at our entire portfolio, average utilization is about 55% to 60%. So there's just a significant layer of discounting that goes on that gives you a lot of flexibility in this kind of lending. And our borrowing basis, the reserve adequacy, is checked literally every 6 months. So there's a borrowing base reevaluation every 6 months. You can't get very far down the road without some soft correction there. A lot of numbers, but I think you get a basic sense of the amount of discounting that goes on here and why this type of lending has been prefaced over the years.
I threw this next slide in really just to, if you kind of get confused on where some of these things are, where's the Marcellus, where's the Haynesville, where's the Barnett, where's the Eagle Ford, where's the Bakken, et cetera, et cetera, I won't show you all those. But if you ever need a reference point, they're all right here.
The final thing I wanted to hit was really natural gas exposure. There's a lot of discussion about the low price of natural gas, and so I just wanted to walk you through sort of our portfolios' exposure to natural gas. First of all, we have about $1.7 billion in reserve-based loan commitments, loans against oil and gas reserves. And if you look at that as sort of one homogenous pool, about 44% of those commitments, that borrowing base, if you will, is oriented to gas. An important thing to understand though is about 2/3 of our customers that have gas hedge, and when they hedge, they hedge about 40% to 80% of current year and the following year so kind of forward 24 months of production. And that hedging really protects a large portion of the portfolio.
So drilling down a bit further, if you say, "Okay. Well, let's look at those bond bases that are greater than 50% natural gas and unhedged." And that will be about 11% of this portfolio, about $100 million in outstandings. And then if you say, "Okay, greater than 50% natural gas unhedged and greater than 80% utilization. In other words, they're pretty heavily advanced on their borrowing base. It's less than 2% of our portfolio." So I think what you can kind of get the sense of fairly quickly is that even with lower gas prices, that there's a lot of kind of structural strength to the portfolio. And we currently have about 9 credits that we're watching closely, only one of which is not rated to pass. So we really have not seen much deterioration in the portfolio. You know that we anticipate it. There are certainly exposures we have on the oil field service side as well. We have about 5 companies that are involved in principally dry gas regions. Only one of those is adversely graded today and so we have not seen a bubble up in our services portfolio either.
And one thing important to know about natural gas and this is -- most people just absolutely can't believe this, but if you look at all the natural gas reserves in the United States, and the production rate on an annual basis, they -- we deplete our natural gas reserves 1/3 a year, 33% a year. And so as you read about companies that are slowing down their natural gas drilling right now, if they slow down for a year, we're down to 2/3 of what we have before. Prices just vary quickly with natural gas despite all the storage features that are out there as opposed to oil where the depletion rate's about 10% a year plus or minus. So there's a natural correction that goes on with natural gas that has a big impact on price.
So I guess, in concluding, there's significant capital that is moving into the energy industry. It has private equity and pension plan money with significant capital on the sidelines to support all aspects of the industry. Based on the way we underwrite, we have very low advance rates, whether it's on the services side or in reserve base, gas prices do adjust fairly quickly. And again, this complexity of drilling today is something that will be a strength in an underpinning of the services industry going forward. We think we've got a very experienced team that's worked in this industry for many years. And while we're certainly very mindful of the volatility, it's something we've been pretty successful at managing through for many years.
James R. Abbott
Thank you to both of you. Next, we're going to have David Blackford. For those of you who are portfolio managers or talk to portfolio managers on a regular basis, you know that timing is everything. And David is the genius on timing, I think. I spent some time talking to a reporter at the California newspaper last week and pointed out him with the banks left and right in California were just dropping like flies, and 1 or 2 quarters, I think with the California Bank & Trust actually reported lost and that was banks to the CDO securities. So California Bank and Trust had some great timing issues. It's not that it's avoided real estate altogether. In fact, it's had a lot of it but it just managed to underwrite it and time it just right. So David?
David E. Blackford
I think a lot of you were in California yesterday. So I'll be brief and quick. California is the 13th -- it's economy is $1.9 trillion, 13% of total U.S. economy. We have all sorts of activity in the Bay Area, all sorts of new companies, a lot of energy. We have the entertainment business in the L.A. area, we had a record export year for 2011. Our focus in the bank is really coastal California. If you look at those 2 slides, the semi-slides, you can see our focus in our brand structure and our assets are primarily located in the Bay Area, Orange County and L.A. and San Diego. 24% of our assets are in San Diego. And when you look at the various degrees of unemployment, we have pretty much avoided Inland Empire, avoided the Central Valley and concentrated in the areas that actually now have positive job growth and better economic activity.
Revenues have been somewhat the same for the last 3 years, reflecting a flat loan portfolio, challenges in the California economy. Pretax earnings, one of the things I look at very carefully is we've been successful in having a pretax earnings, less charge-offs, positive throughout the cycle. One quarter, when we sold CDOs to the holding company, we actually had a loss. Our adjusted pretax, preprovision has returned to pretty much to 2007 levels. Charge-offs were elevated in 2009 and 2010. They returned to a very acceptable rate towards 2011. A fourth quarter charge-off rate was 24 basis points. We early on identified problems in real estate that's California economy are the managed nonaccruals proactively so we really didn't have much of a bubble in nonaccruals and now have made substantial progress. Classified loan balances, when you include the securities, have reached the high point of $725 million. What we focus on more importantly is our classified loans to Tier 1 and reserves. It's now at 24%, which is a very good level of classified loans. The deduction in securities were principally securities sold to the holding company during 2009, 2010, as well as 2011.
I think what we learned most about the cycle is, and it's really hard to anticipate, is late cycle lending requires extraordinary care and discipline. We had a growth economy from about 2002, 2003, in 2007 as far as commercial real estate. You really had to be out of business in 2005 to 2006 to avoid losses. We slowed down our new originations dramatically in 2006, 2007. So our credit quality remains fairly good throughout this cycle. And I'd say the margin there is, as far as loan quality when you're at the top of the cycle, you have to avoid pretty much any exceptions to your lending policy.
The other thing that we've learned, and I think our Arizona and Nevada banks also learned is, is that a downturn in the housing market affects many other industries, it affects commercial real estate. Office buildings are less occupied. Retail sales are down. A lot of other businesses are adversely affected by the concentration with homebuilders in these states. We also learned that transactions out of our core competencies and markets of the limit had disproportionate losses. So from about 2008 forward, we avoided being out of the California market. But we did write this cycle. We had disciplined growth to our loan growth typically throughout the decade, averaged 3% to 4%. So we never had high-growth years. We focused on shareholder value. We had a strong credit culture with experienced credit administrators, experienced lending officers and very little turnover. We avoided all sorts of exotic mortgage products. Our typical mortgage is the old mortgage where you put 20% to 40% down. We focused on jumbos and those always had lower advance rates. We have early and aggressive problem resolution. I think our -- we're an $11 billion bank. Our highest level of OREO is about $11 million. So we never had an OREO problem or OREO expense. We've always had strong core earnings to build up reserves and that's fairing us well. We had 2 very successful FDIC acquisitions, Alliance and Vineyard. And it looks like the profitability will be approaching $250 million to $300 million on growth acquisitions.
The highlights for the bank for 2011, we reached a low point in our loan portfolio in March. Since March, we've grown about $300 million. We expect loan growth of about that in 2012. We had a record year for mortgage production, pretty much all jumbo ARMs along the coast with relatively low advance rates with customer relationships, and that turned out to be a very good way to expand our customer base with about $600 million in 2011. We also added high-quality mini-perms. We found there is a need for bridge financing mini-perms. And we've originated about $900 million of real estate bonds during 2011, average loan-to-value between 59% and 64%. That's today's value, not 2007 values. So a lot of these properties had already dropped to one major adjustment in value or 2. We did have, in our experience in [indiscernible] losses in the Vineyard acquisition, so that will be more profitable than originally anticipated. We've had steady improvement in credit every quarter. However, we do expect that to slow down as assets have become more sticky. The smaller business gone to bankruptcy could have friendly court systems in California. So that takes time to resolve the smaller loans.
Current state of the bank, we're happy to say that we've provided dividends to the holding company for the past 2 quarters and we expect to continue to do so. We have a very valuable core deposit base across the 17 basis points for the fourth quarter. We have one of the highest NIMs in the industry. Our reported NIM of 4.96% reflects the accretion of income of the figured assets, the core NIM is a 4.30%. Our charge-offs in the fourth quarter was 24 basis points and we expect to have good results in 2012.
We have 6 major business lines. I'll go through those very quickly. We have a community bank in San Diego that we operate as a community bank, about $1.5 billion in assets. We have a branch network with a combination of the Sumitomo branches that we acquired in 1998. El Dorado, which we acquired in 2001 and Regency Bank, which we acquired in 2003. Our commercial middle-market business is led by a very strong team of bankers that has a good presence. Our real estate lending is now focused more so on bridge financing many firms and far less so on construction lending. Mortgage lending, we focus on jumbo ARMs with relationships. In fact, we require new deposits each mortgage loan we make. Our SBA lending is general purpose in nature and we've exited all markets except for California.
Our initiatives for 2012. We recently hired a new executive to focus on our branches north of San Diego. During 2010, 2011, we analyzed our branch network. We closed 5 branches while retaining 80% of the deposits. Likewise, we opened up 2 new branches in high-growth areas, Pasadena and Valencia. We're currently revamping our small business delivery. We're now focusing more of our energies and activities in the Bay Area and Silicon Valley and have staffed up there. We have strong focus on cross sell and fee income.
On the operating expenses, it's kind of apples to oranges. So I really won't go through very much to say that our peak OREO expenses were $9.2 million. 2011, they were $3.7 million. This year, we think they'll will be very moderate. Our opportunities for expense reduction will largely come from looking at our branch network and reducing those branches that do not produce a satisfactory income level. FDIC expense will decline during 2012. We have reduced FTEs by 69 in 2000 since 2010. We expect a wide reduction in 2012, and we expect further reductions as we rationalize our branches north of San Diego. Thank you.
James R. Abbott
Thank you, David. I think one real quick thing here. As part of the Vectra Bank, which is in Colorado presentation, Bruce Alexander, our CEO, is going to talk for a couple of minutes about an initiative that he and Keith Maio, our CEO from the Arizona franchise, National Bank of Arizona. They spearheaded an initiative to consolidate a lot of our mortgage operations in terms of trying to cut cost. And so I'd like to ask both of them to just come up and just maybe talk for 2 to 4 minutes about how that works and how you were able to get that done. One of the questions will get all the time and so you're going to consolidate the charters to get the cost out and this is a good example of how you don't have to do that to do that. So this is -- we're calling an audible here, so Bruce I'll let you start.
Harris talked at the beginning of the session today about this concept of best practices and 2.5, 3.5 years ago, we can be in a group of all the affiliate subject matter experts on mortgage and we got together to see how does everybody do everything? What are the opportunities and what are the risks? Because we found at the end of this difficult mortgage time that there were some real opportunities to make things more consistent. So we gathered the group together. We met on a regular basis for a couple of years and came up with the new initiative to really redirect to our mortgage group almost as a line of business. The sales focus stated in each one of the markets, everybody had the opportunity to grow and manage it relative to their own initiatives but we really found a way to reduce risk and reduce cost like harmonizing process. So number one, we built a plan to move forward on loan origination system with an opportunity of building greater discipline, reducing cost and cost to file. We think that number is an example of the opportunity of what science can do. It could take $6 million to $10 million out of the mortgage enterprise across the affiliates, which is a pretty significant number. In addition to that, it allows us to improve our enterprise risk management as it relates to mortgage and that will build much better financial reporting systems and backroom systems. We're also looking at a more consistent approach to loan servicing. As you know, with what's happening with the really big mortgage companies right now, that's been a key area of exposure. So we're commonizing our systems and commonizing our vendors to take cost out of that system. And we're also looking the same thing with the end purchases of our loan to combine our buying power or selling power, if you will, to improve margins.
So it's really a way to keep the ethic of the company and local sales initiatives intact, but to combine best practices and to take this kind of expense initiative and reduce the expense of the enterprise and build [indiscernible]. So you want to add anything?
Keith D. Maio
I'll just add a couple of things. The blueprint for this was done in this company about 5 years ago with the treasury management fees, and Bruce and I focused on what we did there. And again, it's about not changing the front end, not changing really the customer-facing people that process but consolidating the back end and you end up with not just less on the expense side, but again on the mortgage side as in the treasury side. I think, for a lower expense, we're going to end up with a much better product. We'll have channels that we can touch our clients through that we wouldn't have had otherwise because we all have created our own touch point. So I hope this helps revenue side and the expense side at the same time. Thank you.
James R. Abbott
Thank you very much. Also true to our expense-saving initiatives, somebody mentioned that design that's famous for -- on the [indiscernible] Investor Day by giving out great prizes or great gifts, I guess, we should say. True to our expense-saving initiatives, we're not doing anything this year. We do hope you'll come back 2 years from now. After Harris' concluding remarks, we will actually -- we're joining to adjourn the webcast, so part ways at that point and we thank most of you on the webcast for joining us. We will go to the breakout rooms. We have rooms that you're assigned to and so I'll call those names out and which rooms and will follow Mary Ann, myself and Michelle and Drew, I think, will probably go and take you where you're going. And then, the CEOs will rotate, about 25 minutes per session, and they will need to be at their new location at -- on half hour. And so there's not a lot of extra time in there. So I know how you guys are. You want to ask that last question but we're going to have cut you off 25 minutes into the breakout session. So with that, Harris, would you join us up here for just a couple of minutes and maybe Doyle as well for some concluding remarks?
Thank you, James. I would note that -- I was reminded the other day of Mitt Romney when he came out here to run the Olympics. One of first things he did was he had this elaborate lunch and the first meeting they had pizzas and it was about $8 a pizza. He sliced them into 5 pieces each and sold them for $2 a slice to each of the -- to everybody at the meeting. So we're making $2 per pizza. We didn't charge you for lunch. We haven't quite gone that far yet. I want to thank all of you for being with us. I hope that -- I started off by saying that we would -- I was going to tell you what we're going to tell you and we're going to tell you and I was going to tell you what we told you. I think as we look out over the next year, we expect that loan demand continues to be sluggish throughout the industry. We're certainly seeing that. We do expect to see the runoff in the C&D portfolio. We're tapering off and in some places even starting to grow a little bit. That should be fundamentally helpful and seeing that net loan growth. So we expect balances certainly to be stable, probably moderately higher. Credit trend, I think you've got a pretty good dose of that today on virtually every front. Credit trends continue to improve in really pretty good shape. Reserve releases will probably continue at a moderate rate and so we got -- we're at a fairly conservative place and that could have still some leg in it. In our core net interest income, we expect that that's going to continue to be reasonably stable or certainly some pressures out there. We have a little further work that we can do on the private side. And we're seeing some signs of some stabilization on the pricing pressures on commercial deals. But it's still -- it's a tough environment and the yield curve, obviously, is a factor there. So that -- you could some compression there. We think it will be reasonably modest. Core interest -- non-interest income, we think is pretty stable. We expect that would probably see some growth. Non-interest expense coming -- continue to come down a little bit, typically driven by credit-related cost. Though we have a lot of other things underway, we were trying to continue to trim what we can. Risk-based capital ratio, we expect to continue to strengthen. We talked about the stress test and regulators and TARP, et cetera. That's something that [indiscernible] until we fit some work guidance back in. I think we feel a lot of strength in this company. We kept people together. When I go out and meet with relationship officers, what I see there is a group of people who are really committed to continuing to build these great banks that we have. We've gotten to know this year and other years, some of the leaders of these banks. I can't tell you how much I appreciate what they do. They really are the strength of this place. They and their people out in each of these banks are doing a great job and you'll get more of that in these breakout sessions. So again, thanks for all of you for being with us. Those who are listening in on webcast, thank you. And we look forward to seeing you again in 2 years. And if you have any other questions before we walk up into the -- Doyle, anything you want to add? All right. Okay, we'll go to the breakout session. Thanks again.
James R. Abbott
Thank you, again, everyone, on the webcast. We're going to go ahead and shut that down now at this point.