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Executives

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

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

Doyle L. Arnold - Vice Chairman, Chief Financial Officer and Executive Vice Presiden

Kenneth E. Peterson - Chief Credit Officer and Executive Vice President

Unknown Executive -

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

Analysts

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

Jeffrey Lengler - Goldman Sachs Group Inc., Research Division

Ken A. Zerbe - Morgan Stanley, Research Division

Leanne Erika Penala - BofA Merrill Lynch, Research Division

David Rochester - Deutsche Bank AG, Research Division

R. Scott Siefers

Craig Siegenthaler - Crédit Suisse AG, Research Division

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

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

Joe Morford - RBC Capital Markets, LLC, Research Division

Kenneth M. Usdin - Jefferies & Company, Inc., Research Division

Michael Turner - Compass Point Research & Trading, LLC

Zions Bancorp. (ZION) Q1 2012 Earnings Call April 23, 2012 5:30 PM ET

Operator

Welcome to the Zions Bancorporation First Quarter 2012 Earnings Call. This call is being recorded. I will now turn the time over to James Abbott.

James R. Abbott

Good evening, and we welcome you to this conference call to discuss our first quarter 2012 results. I would like to remind you that during this call, we will be making forward-looking statements and that actual results may differ materially. We encourage you to review the disclaimer in the press release dealing with forward-looking information, which applies equally to statements made in this call. We will be referring to several schedules in the press release during this call. If you do not yet have a copy of the press release, it is available on our website at zionsbancorporation.com. We will limit the length of this call to 1 hour, which will include time for you to ask questions. [Operator Instructions] Now, we'll turn the time over to Harris Simmons, our Chairman and Chief Executive Officer. Harris?

Harris H. Simmons

Thank you very much, James, and we want to welcome all of you to this earnings call this evening. We are, obviously, particularly pleased by the progress we are able to make in the first quarter with regard to our capital plan, as I suspect most of you know, the reduction in our overall cost of capital and the simplification of our capital structure over the next 3 to 5 years should be one of the primary drivers of improvement in our profitability and return on equity. With redemption of $700 million of TARP at the end of March and with the targeted redemption of the remainder of TARP in the second half of this year, we will move meaningfully closer to what we believe to be the long-term earnings power of the company.

Looking to the fundamentals, overall, we are quite pleased with the progress on asset quality this quarter, although there's some noise in the classified loan trends, which is mentioned in the release and which we will address a bit later in the call. But net charge-offs declined 43% from the fourth quarter level to an annualized 60 basis points of loans, which is a level that we haven't seen since the first quarter of 2008.

We also saw some further decline in nonaccrual loans, which declined 4% sequentially. Nonaccrual loans are down more than 60% from the peak, but at 2.4% of loans we know that we still have some further work to do to get them down to a more normalized level consistent with our history.

The softest spot for us in the first quarter was loan growth compared to the fourth quarter, which is something we also highlighted as a first quarter challenge at our last earnings call.

As noted in the press release, most of this decline occurred in January and February. While average loans were essentially stable, the ending balance in March was down 1.5% from where it was at the beginning of the quarter. About 1/2 of the decline came from owner occupied loans and about 1/3 from commercial and industrial loans.

This is partially driven by our business mix, which is skewed toward the small business customer, where we saw less demand in the quarter. We do see signs that borrowing for small business loan customers will strengthen in the second quarter. And as new financial statements come in and they're -- and these businesses continue to show a little more strength, we expect that more and more of them will be eligible for additional loans to expand their businesses.

On the middle market and corporate banking side, declines in balances were generally attributable to a paydown on lines of credit rather than the loss of a customer. We are actually seeing some growth in commitments, but we're seeing line utilization down. Our line utilization rate declined to 32.3% from 35% just 3 months ago. So it's about as weak as we've seen it for some time.

Although loan pricing remains competitive, it was generally stable compared to the prior quarter. We do see some moderate loosening of structure and terms in the marketplace. We have generally resisted that pressure and we'd expect to continue to do so.

I'm also pleased to report that noninterest expense declined. This has been an area of focus for all of us, something that we continue to watch closely. Excluding the noisy items in the fourth quarter, expenses declined 4% from the fourth quarter. Much of this decline is attributable to an improvement in credit-related items, which is consistent with our past guidance.

So that overview are some of the major items. I'll ask Doyle Arnold, our Vice Chairman and Chief Financial Officer, to go through the quarterly performance. Doyle?

Doyle L. Arnold

Thanks, Harris, and good afternoon, good evening everyone. I hope you guys on the East Coast are weathering the weather satisfactorily.

As noted in the release, we posted net income applicable to common shareholders of $25.5 million or $0.14 per diluted common share. We've also presented the earnings as we usually do in a way that excludes the noncash sub debt amortization impact and the FDIC loan discount accretion. And we think that adjusted for those items is useful to longer-term oriented investors, as we do not expect those income and expense items to be with us into perpetuity.

And additionally, in the first quarter, we had one other item which we'll call out and that's the $20 million accelerated discount amortization related to the value attributed to the warrants in our TARP preferred that was then triggered by the redemption of $700 million of that TARP in late March. So that flows through as additional preferred dividends and that explains the jump of $20 million in preferred dividends this quarter. Excluding those items, the earnings were $0.33 a share. While there was some other modest fee income noise in the quarter, those items largely cancel out.

Turning now to revenue drivers, which includes a discussion on loans and margin. On Page 12 of the release is a table of loan balances by type. Before we get the details, much of the balance -- decline in balances is due to a decline in production compared to the fourth quarter 2011. Production here includes both new origination, as well as draws on existing lines of credit. While production was down from the fourth quarter, it was very basically identical to the first quarter of last year. And on most -- on the most cyclical loan type, such as C&I, the linked quarter decline was pretty close to the decline we experienced last year as well.

With that as background, commercial and industrial loans finished the prior quarter relatively strong, up 6% sequentially or $602 million, followed by a decline of about $178 million or 2% in the first quarter of 2012. C&I loans have been stable to modestly increasing since early March. Now if you recall at the end of the year, we cautioned you that we thought a lot of the run-up in C&I balances in the fourth quarter was some window dressing and it just kind of seemed too good to be true or to persist and that proved to be the case. We saw essentially all of that run-up reverse itself in the first 2 months of the quarter, and then begin to stabilize and there's been slow growth in just about every week since then, including through last Friday. So the window dressing appears to have been undressed and we're back to a normal, slow, incremental loan growth it would appear at this point. The new C&I loans are priced on average relatively neutral to our overall net interest margin with duration and credit quality consistent with prior quarters.

Loan pricing has remained in a tight range for about the last 4 quarters. The decline in our owner occupied loan portfolio explains about half the decline in total loans this quarter, largely attributable to a decision made several quarters ago as part of our new concentration risk management efforts to selectively reduce certain aspects of our exposure in our National Real Estate business. For example, reducing exposure in geographic jurisdictions where local laws make problem loan workouts more difficult and time consuming.

As many of you are aware, Zions is the largest SBA 504 lender in the country, both by number of loans and by origination volumes. These loans have very low loan-to-value ratios of origination and as a result, loss rates have performed materially better than other loan types, peaking at about 2.4% and following currently to less than 1% annualized year-to-date, basically, first quarter. It's a business we've operated for many years and to be clear, we're not exiting the business, but we have elected to exit select markets in such where the obstacles to collecting on bad debt are -- make it difficult or very cumbersome.

We have also elected to reduce concentration in the hospitality sector of this portfolio. We do expect several hundred million dollars more of further contraction in this portfolio during the year, which will pressure the overall trend in owner-occupied loans.

Construction, development loans did decline for the 16th consecutive quarter. However, the rate of net decline does appear to be slowing. And based on production statistics, we do expect the leveling off in this portfolio and possibly some growth later in the year. Most of the new construction loan balances are commercial, but residential development projects in some markets are strengthening and our commitments are now growing. Although relative to historical loan growth rates, we would describe demand for such loans as relatively modest at this point.

Term CRE loans experienced continued growth and with the slower attrition in the C&D balances, total CRE loans increased for the first time in 3 years, basically, 12 quarters.

Turning now to our net interest margin on Page 16. You'll note that the GAAP NIM compressed by 13 basis points, 8 basis points of which is explained by changes to non-core items such as the sub debt conversion and accretion on acquired loans as reconciled on Page 17 of the release.

The core NIM declined by 5 basis points from the prior quarter, which is consistent with the guidance we gave on our call in January and at various investor meetings and presentations throughout the quarter.

About 2 points of the core NIM conversion -- compression, excuse me -- core NIM compression was due to the increase in low-yielding, short duration cash and securities, and about 3 basis points due to the compression of loan yields.

Loan yield compression is attributable to 2 factors: First, adjustable rate loans resetting to lower rates as the repricing index is lower now than it was several years ago when the loans were originally booked; and secondly, maturing loans, many of which had rate floors, were replaced by new loans at lower coupons or lower floors, compared to loans originated when spreads were higher.

As we mentioned in January, we expect that the NIM will be under pressure throughout the next couple of years due to these forces by approximately 2 to 4 basis points per quarter. Nevertheless, if and as loan growth strengthens and we're able to trade cash for loans, the pickup in net interest income should offset the repricing pressure.

Finally, the balance sheet continues to remain quite asset sensitive, where an upward parallel shift in the yield curve of 200 basis points would result in an increase to the net interest income of more than 10%.

Turning to credit, I'll be fairly brief. I'll make 3 points. We're, of course, pleased with the material improvement in net charge-offs. Our NPA resolution volumes dropped somewhat from the fourth quarter, but resolution volumes were consistent with 2010 and 2011 averages.

Favorable and unfavorable resolution rates were also consistent with the 2010 and '11 averages. We mentioned in the press release that there was a change in grading of loans in our National Real Estate portfolio. I want to point that out. This change in policy caused $175 million of loans that were fully current as to principal and interest to be downgraded to classified status in the first quarter.

In the case of these $175 million, they were downgraded based on noncurrent, that is 2010, financial statements, to establish debt service coverage ratios and other ability to service the debt. Based on those ratios, the debt service coverage ratio was less than 1.2:1, resulting in net downgrade to classified. We believe that when we receive more current financial statements based on discussions with these borrowers, namely 2011 financials as they file our tax returns, et cetera, their financial condition and debt service coverage ratios will have broadly improved and that many of these downgraded loans will revert to pass grades over the next 2 quarters.

This loan -- change in loan grading is a change in practice, not a true change in the underlying risk and it does not signal any expectation on our part that future losses coming from that portfolio are going to increase.

Finally, I'd point out that construction development loans this quarter actually experienced a small net recovery, which is quite a change from where we were a couple of years ago, in the third quarter of 2009, we had $219 million of net losses in that category alone. So switching to a net recovery is quite a turnaround.

Let me now refer you to Page 6 of the text in the release. We have changed -- we hope for in a way that's more informative to you, the way we present the CDO portfolio. As you recall, previously, for a number of quarters, we've been showing this table, kind of oriented around bank CDOs and other CDOs and then within each category rank, sorting them based on the original rating agency rating. We will show that table in the 10-Q, alongside this new table, but we are -- we think this new one is more descriptive of where we think the risk in the portfolio is and where we think the recovery potential in the portfolio is.

The top part of this is -- it's basically now 2 broad categories, are performing and nonperforming CDOs. Notice the performing CDOs have a par value of just under $1.5 billion and a carrying value of just over $1 billion. None of these securities has ever missed a payment despite the severe trauma the banking system experienced, and we feel reasonably confident that we're going to get most of the discount in this portfolio back over time based on our cash flow modeling and so forth. This represents a potentially significant potential benefit to our book value and tangible common equity ratios. We recovered all of it that would be accretive to tangible common equity by about 7% to 8%.

The nonperforming CDOs which are -- you can see there about -- just over -- just under $1.1 billion of nonperforming with a carrying value of $200 million, fall onto 2 categories: Those that have experienced credit impairment or OTTI recently, mainly within the last 12 months; and those that have experienced it in the past, but not within the last 12 months.

We expect to see some of this discount in the nonperforming CDOs accrete back into equity. But if there's impairment to be taken in the future, we would expect most of it to come out of the $200 million of unrealized loss in those that have experienced credit impairment within the last 12 months, even as the OCI mark on other CDOs may improve.

On a related note, I'd highlight that the AOCI mark improved modestly this quarter as a result of slightly lower risk premia on risky assets at the end of March compared to December. Additionally, I would note that both S&P and Moody's have begun to review and selectively upgrade bank trust preferred securities. And as those upgrades continue, we would expect that the market for these securities may begin to re-liquify or deepen and liquidity discounts to moderate somewhat.

On a related note, of the $10 million and change that we took in OTTI this quarter, about 30% was due to prepayments on trust preferred issues that were in the CDO pools. So we are seeing that impact that we described in our Investor Day, but the remainder was due to model credit deterioration in a few banks in our exposure pool.

Regarding capital, now the GAAP tangible common equity ratio increased to 6.89% from 6.77% in the prior quarter, and the Tier 1 common ratio increased to an estimated 9.70% from 9.57% in the prior quarter. While not yet a formally -- formalized regulatory ratio, we estimate that our Basel III Tier 1 common ratio fully phased in would have been approximately 8.2% at the end of this quarter, which is also a continued improvement from numbers we've disclosed to you previously.

As mentioned in the release, we, and in the 8-K, we did redeem 50% or $700 million of TARP late in the quarter, leaving us with $700 million to go. We currently do still expect to redeem this sometime in the second half of this year. We also issued $300 million of senior notes to enable us to maintain a strong liquidity position at the parent company.

Finally, turning now to guidance or outlook for the next couple of few quarters. We do expect moderate organic loan growth, which we expect to strengthen a bit as we progress through the year. However, yield compressions stemming from loan resets should act as an offset. And the net result may be a slight decline in net interest income in the second quarter.

Future net interest income trends will depend in part on the rate of earning asset growth, particularly loans, which as I said, we do expect to strengthen a bit as the year goes on. OTTI from the securities portfolio should remain low as fewer banks are failing, more are recovering and our model is quite conservative at predicting failures.

Offsetting this trend is faster bank prepayments for the underlying trust preferred securities, as we've mentioned. This has the effect of diverting cash to the senior tranches that we own, potentially improving AOCI, but removes future cash flow support from the mezzanine tranches, potentially resulting in additional OTTI.

We do expect the net of those 2 effects to be accretive to tangible common equity. And for more detail about this phenomenon, where we went through some hypothetical scenarios to show you the modeled impact, you can refer back to our Investor Day slide deck from February 16.

Noninterest expense should generally continue to trend stable to perhaps slightly lower, driven primarily by credit cost improvement, but also by, as Harris mentioned, our strong focus on continuing to improve operational efficiency. Seasonal expenses, like payroll taxes, will decline as the year progresses. And as loan origination volume improves, some of the compensation will be deferred rather than expensed through the salary benefit line.

Our view of the economic climate is that we're still, we're in a generally protracted and tepid recovery in the U.S., while foreign countries, including Europe and the BRIC countries, are struggling with recession or slightly -- or significantly slowing economic growth rates.

While we have no, virtually no direct foreign exposures, I think many of you know, we remain somewhat cautious about the potential impact on our domestic customer base, and therefore, plan to exercise caution with our lending standards, loan pricing and reserve factors.

With that said, we're actually -- remain moderately positive with regard to the company's outlook over the next several quarters, particularly due to our expectation of continued improvement in credit quality. We expect net charge-offs to be stable to declining from the first quarter level, not a big step function down like you saw between fourth and first, but stable to a declining trend still from there. And we do expect, therefore, provisions to remain low and acknowledge the possibility that the provision may be negative in one or more quarters.

With that, I will turn the session back to our moderator and invite you to queue up your questions and we'll do our best to answer them.

Question-and-Answer Session

Operator

[Operator Instructions] Our first caller in queue is Paul Miller with FBR Capital Markets.

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

A quick question is that across the different geographies, we're hearing places like Phoenix and Vegas are starting to have some good asset price recoveries, a lot of investors coming into the market. Are you seeing different performances from the different geographies you guys are in, especially California versus Phoenix and Texas and Vegas?

Doyle L. Arnold

I'll see if Harris or Ken wants to -- Harris, do you want to comment on that?

Harris H. Simmons

I guess we are generally seeing continued improvement across the board. We saw -- we did see in the Nevada market some pretty good improvement during the quarter in terms of just credit quality. What we're not seeing is -- I mean, loan demand remains really weak in those markets, but we are seeing, even in some of these really tough markets, that things are getting better. We're seeing in the Arizona market, for example, better movement in the housing market. If anybody can qualify for a conforming loan, so in the reasonably priced kind of segment of the market, things are actually moving along. It's still weak in the upper end, but there are some very real signs of improvement in some of these tough markets.

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

And then on price competitiveness, are you seeing different levels of price competitiveness in some of the bigger banks or is it pretty much it's very competitive out West across the board?

Harris H. Simmons

Well, I think, I mean you're seeing it pretty competitive across the board. We're -- I don't know, just anecdotally, I'm hearing less about a couple of players that were really aggressive 6 or 9 months ago, but it's still -- everybody's looking for the good deals and everybody is strapped for the quality earning assets, and so it's pretty competitive. And that's -- as we've said, starting to see it maybe a little bit in structure. So until we see some growth, I think we're going to continue to see a lot of price competition.

Operator

Our next question in queue is from Ryan Nash with Goldman Sachs.

Jeffrey Lengler - Goldman Sachs Group Inc., Research Division

This is actually Jeff Lengler filling in for Ryan Nash. Just on the available for security T-yields [ph], it looks like they're up about 60 basis points linked quarter, but the balances are down, is that somewhat related to TARP repayment, or is there anything else going on there?

Harris H. Simmons

We actually sold some U.S. Treasury securities in the fourth quarter and which ultimately rolled into cash and now has been used to pay off the $700 million to TARP. So what you're seeing is that effect going on.

Doyle L. Arnold

I think you're seeing a subtraction of very low yielding securities from the securities mix, not a purchase of something that has an interesting yield at a longer duration.

Jeffrey Lengler - Goldman Sachs Group Inc., Research Division

Okay, that makes sense. And then just secondly, on the classified loan reclass, was this an internal decision or was it driven by something on the outside? And was there any impact on the allowance or the P&L for the quarter?

Doyle L. Arnold

There was OCC, their control of the currency asked us to make the change, to go down to a smaller loan size, where we analyzed individual financials and more aggressively go after those financials. And no, it basically had no impact on our assessment of risk, and therefore, of the loan loss reserve.

Operator

Your next question is from Ken Zerbe with Morgan Stanley.

Ken A. Zerbe - Morgan Stanley, Research Division

Doyle, just to start off on the last question on the provision expense, if the change in the grading of loans for classified didn't add to the provision expense, is there anything to read into the very low provision expense number this quarter, but still a little bit higher than we were expecting? Because your comments suggest the provision could be lower or negative going forward. So just trying to reconcile the 2.

Doyle L. Arnold

I'm tempted to turn the mic over to the gentleman who is here with us who runs our quantitative models and runs this whole process, but -- he, basically, runs the company now for bad debts. No, it's just -- I mean, we looked at that and we knew that question was going to come up because it is counterintuitive. But basically, all the trends are favorable and you shouldn't read much of anything into it. If I did turn the forum over to him, he would give you an erudite explanation of first derivatives and second derivative, rates of change that you'd -- eyes would glaze over, so I would just say don't worry about it, if you can do that.

Ken A. Zerbe - Morgan Stanley, Research Division

I think I can probably do that. So can you, just a quick -- a quick follow-up question that was just on TARP, your comments in the release say second half of 2012, I think previously, we heard, sort of broadly, end of 2012. Are you trying to indicate that you could repay a little bit sooner?

Doyle L. Arnold

I hadn't even realized we made that statement. I think -- let me just say, I think the reality is probably are something along the following [indiscernible]. I think -- well, there's proposed regulations out there now that will require all of the top 30-ish banks to do another stress test, self-defined, at mid-year based on their balance sheets, more current. Probably the underlying reality is that there've been no rules published. I'm not sure what, if any, rules will guide that, but my current expectation is that we will do something along those lines and we probably then won't -- we will wait until we know the results and maybe have showed them to the Fed before -- and you put all this together and it kind of says late third or sometime in the fourth quarter, so it wasn't intended to be a change in guidance. Reality is it's going to be maybe in the last third of the year, I would suspect.

Operator

Our next question is from Erika Penala with BOA Merrill Lynch.

Leanne Erika Penala - BofA Merrill Lynch, Research Division

Doyle, I appreciate the color that you gave on NII, but I was just wondering if you could help us size the impact of the resets? Because it sounds like that's what's driving your guidance for lower NIM quarter-over-quarter. So I guess how much of your loan portfolio will reset in 2012? And what's the delta in terms of the yield to throwing off that versus where it's repricing to?

Doyle L. Arnold

I'm not sure. I'll let James answer. James is raising his hand. He wants to answer your question. So we're going to give it to him.

James R. Abbott

In terms of floors, we broke it out a little bit in the Analyst Day presentation so you can see it by year that way. We broke it into 2012, 2013, 2014, in fact, so you can see it broken down there. But it is closer to the 3, 3.5 basis points per quarter when you add floors and resets together in the next 1 or 2 quarters. I think it's the next 2 quarters and it's what -- and then it starts to tail off. And as you get into 2013, it's about 2 basis points a quarter on the combined basis for those 2 different effects.

Leanne Erika Penala - BofA Merrill Lynch, Research Division

Got it.

Doyle L. Arnold

And that, I believe, is consistent with guidance we've given over the last couple of months.

Leanne Erika Penala - BofA Merrill Lynch, Research Division

Okay. And in terms of the provision, I appreciate that there's a very mechanical process in terms of how it's going to be drawn down this year. But I guess as we're looking to a more normal run rate of earnings for Zion, what does the model say in terms of where the reserve can eventually bottom to? What's, sort of, was appropriate for the new risk profile of this company or pro forma risk profile for this company?

Doyle L. Arnold

Yes, really, to fully answer that question, you almost have to also tell me what rules you think the FASB is going to enact, and they are evolving, kind of even as we speak, from a incurred loss model much more strongly in the direction of an expected loss model, including probability weighted different economic scenarios, one of which could be a severe stress scenario. So until all that shakes out, I don't know where we'll settle out. At some point, what you ought to look at is really the -- what's a normalized through the cycle run rate of losses versus -- because what that's going to determine, on average, is what the provision is. And I don't know, I -- we have dramatically reduced our exposure to the loan category that caused a hugely disproportionate share of our charge-offs through this last cycle, namely land and development lending. So with that said, I don't know, maybe 50 basis points a year and then you tell me how many years of reserve we need -- we'll need to have under a FASB regime.

Harris H. Simmons

I think it's also -- it's a function of how the economy is performing, obviously, and that's something that -- -- beyond our control, so.

Doyle L. Arnold

But I think whatever that normalized rate of provision is and level of reserve is, we're probably still a year or 2 away from it. There is just too many other moving parts. But I think the general trend right now based on what we see is that the reserve will continue to come down and the provision will, for at least the next 2 or 3 quarters, will be in the neighborhood of 0, slightly positive to slightly negative.

Operator

The next question is from Dave Rochester from Deutsche Bank.

David Rochester - Deutsche Bank AG, Research Division

Just on the pipeline, just real quick, you talk about loans stabilizing in March. Can you talk about which sub banks are the bright spots in terms of the growth trends? And was it mainly C&I that you saw the strength or was it also in another areas?

Doyle L. Arnold

Term CRE and C&I and some of the term CRE was completion of commercial construction projects that are underwriting criteria for conversion into term loans. And in terms of geography, I think, probably Amegy was the strongest, again, and Vectra was pretty strong and California. Those were the 3 positive highlights. And Utah, on a net basis, was probably the weakest because that's where that National Real Estate loan portfolio that we are shrinking, intentionally, is housed.

David Rochester - Deutsche Bank AG, Research Division

Okay, thanks for the color there. And just real quick on Amegy, what was most of the growth there? Was that primarily larger, with large corporate middle-market syndicated type credits or maybe some color there?

Doyle L. Arnold

It was C&I. Ken or Harris, do you have more color than that on whether it was syndicated loans or...?

Kenneth E. Peterson

I would just chime in on the syndicated credit side, our syndicated credit portfolio book on a net basis, so loans purchased minus loans sold, shrank by about $250 million linked quarter. So...

Harris H. Simmons

Syndicated book actually ran off.

Unknown Executive

We had broad-based C&I and some 20% in the energy sector at Amegy.

Operator

Your next question in queue is from Scott Siefers with Sandler O'Neill.

R. Scott Siefers

So I was wondering if maybe you could talk about kind of the capital structure going forward. I mean, obviously, that's going to be a big part of the story in the next few years. But now that you're part of the annual, or I guess even semiannual, stress test, how do you see that playing out? What kind of flexibility do you guys think you'll have to improve and simplify the capital structure? Or will it be kind of once a year, we'll get the outlook for what you plan to do for the following 12 months? How do you see that playing out based on what you've seen so far?

Doyle L. Arnold

Well, there are few, if any, precedents for modifications to approve capital plans on an interim basis out there. I guess Citi, it sounds like either is planning to reapply. They were turned down, we were accepted. I think what I would guide you toward what we disclosed in our Investor Day back in February as current and still valid thinking on a long-term capital structure, namely that we would have 9% to 10% Tier 1 common even in paranormal times. With the current risk profile, we would have a couple of percentage points of preferred, which would, as a percent of risk-based cap -- risk-based assets, excuse me -- that would actually net to less dollars of preferred than we have outstanding today. And then some sub debt, maybe a small layer of sub debt and a couple of percent layer of senior debt. Now, it's going to take 2 to 3 years, as I indicated then, to get there, given call dates and other things like that. So I'm not sure if there's any more I could tell you, but I'll give you a chance to ask your follow-up on that regard, if you want.

R. Scott Siefers

No, I think that's broadly what I was looking for. I was just kind of looking for a feel based on having gone through the sort of first iteration. So that's helpful.

Doyle L. Arnold

I think, I will add that, of course, we've tried to look with keen interest at the CCAR banks, the larger banks, published results. And what the Fed found versus what they thought was their result, and of course, it's no secret that the Fed came up with a lot larger haircuts than the companies did, generally. The biggest difference seems to be in first and second mortgages and cards, which are a more modest part of our portfolio but nonetheless, it looks like the Fed has some fairly harsh models out there.

Operator

The next question is from Craig Siegenthaler with Crédit Suisse.

Craig Siegenthaler - Crédit Suisse AG, Research Division

First, just wondering if you can update us on your strategy for the growth of the available for sale securities portfolio here, especially given that the portfolio was pretty stable this quarter?

Doyle L. Arnold

I mean there's just not much out there to purchase that looks attractive from a duration and risk standpoint.

David E. Blackford

Here's the criteria. If you could find some of these securities, I'd be happy to talk to you. They need to be floating right because we don't want to give away the assets sensitivity. They need to have a low risk weighting because we don't want to reduce our capital ratios as -- so it means they probably need to be government or agency guaranteed, and I'd like to have them amortizing and I'd like to have them paid off in short of 15 years. And then I'd like to have the spread over LIBOR. So if you could actually come up with something like that, I'd be happy to discuss it with you.

Craig Siegenthaler - Crédit Suisse AG, Research Division

Is there anything in that bucket?

David E. Blackford

Not much.

Craig Siegenthaler - Crédit Suisse AG, Research Division

So I'm guessing we should sort of see this portfolio continue to decline, but maybe at a slower pace than we saw at the fourth quarter.

David E. Blackford

Yes. It will be slower. I mean, again, what made -- what caused it to drop in the fourth quarter, and of course, the averages are subject, or just what was described, is we had $700 million of treasury bills, which we actually cashed in, in the fourth quarter and that's the cash that we used to then pay down TARP or part of the cash we used to pay down TARP in the first quarter.

Doyle L. Arnold

And we have no more treasury bills, if that helps you.

Craig Siegenthaler - Crédit Suisse AG, Research Division

Is it basically all MBS? And also muni at this point, if I were to look at the composition?

David E. Blackford

We're own very, very little MBS. I think it's less than $200 million. Basically, the portfolio is made up of munis, about $800 million of munis. It's got some MBS, but then there are a lot of SBA pools, we have about $1.2 billion of SBA pools which are floating-rate amortizing and pretty much it.

David E. Blackford

[indiscernible] Of the CDOs, those CDOs, we still -- I mean we've given you a chart on the CDOs, that'll get you to the numbers. [indiscernible] the SBAs, the mortgage-backed securities and the CDOs, you'll get to the number.

Doyle L. Arnold

And the CDO portfolio is not growing.

David E. Blackford

That's right. It's shrinking through prepayments and OTTI, if you hadn't noticed.

Doyle L. Arnold

And the occasional sale.

Operator

The next question in queue is from John Pancari with Evercore Partners.

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

Can you give us some more color around the -- your outlook for credit-related expenses going forward? I mean it came down nicely this quarter. I just wanted to get an idea of how much more room you have there to see some improvement?

Doyle L. Arnold

I think there's still quite a bit of room between where it is and where it will be in a really normal world, but it was quite a step down this quarter. You shouldn't expect that kind of a step down in the next quarter, I don't think. There was less OREO resolutions this quarter. There was a lot of OREO resolution in the fourth quarter, so there's a little quarter-to-quarter noise there. The general trend should, though, should be stable to continuing to decline from here.

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

Okay. All right. And then secondly on your moderate loan growth outlook, I just want to see if we can get some additional color there or maybe if you can quantify your outlook there in terms of growth, particularly following a quarter like this, where we saw the runoff outpace the production? And then separately, can you just elaborate a little bit more on the timing of your remaining runoff? I know you gave us a little bit of color there on construction and the National Real Estate, but let me get an idea of the timing of when we really see that end.

Doyle L. Arnold

I've got to be candid. I mean it's really hard to square the circle about loan growth. The banks continue to report that their pipelines are pretty strong. Commitments are increasing, but draws on commitments were, as I think we said earlier in this call, commercial line utilization is at its lowest point since I've been paying attention to it for 4 or 5 years now. And that's either a sign -- that's a sign of 1 of 2 things, either people are scared to death and they're paying down their lines or we have had growth in lines and new originations. So maybe they're taking out new lines and loading their pistol to fire away because they think things are getting better and it's hard to know right now. Generally, though, the pipelines remain strong. So the pace of conversion into drawn loans is somewhat frustratingly slow. On the decline in those 2 runoff portfolios, well, it's really 3, the smallest one is the FDIC-assisted loans, which are going down, kind of $60 million a quarter or so, and that will be slowly kind of accreting, slowing down as we get further and further into the pile. The National Real Estate decline of a few hundred million will occur kind of throughout the year, but should -- our general sense is that by the end of this year that portfolio should begin to approach a steady-state, I believe. And then the rate of decline in the C&D portfolio already seems to have shallowed quite a bit over the last couple of months. And you've probably read some of the reports that we -- that have been in the public about some revival in housing and we're seeing it more commercial maybe. But I think there's reason to hope, that reason to think that the C&D decline may be largely behind us, maybe reaching a steady-state within the -- or bottom at least, within the next quarter or 2.

Unknown Executive

I would just add. Was that Harris trying to...

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

No, that was me trying to say something else.

Doyle L. Arnold

Okay, go ahead. What's your follow-up?

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

No, I was about to say thanks for the color, but I believe you're elaborating?

Unknown Executive

Well, I was just going to say, John, that the commercial commitments were up 3% linked quarter, which is part of the reason why the line utilization rate fell. But it's just unclear when those draws will occur, if ever. So some of them are liquidity backup lines of credit, some of them are commercial -- or rather construction lines of credit, which we do expect to find [indiscernible] draw, right, when constructions starts, right?

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

That syndicated decline that you mentioned, the $250 million syndicated decline, was that partly related to the national CRE book?

Unknown Executive

No, no, that would be mostly out of Amegy and totally unrelated to the National Real Estate Group, which is owner-occupied kind of -- much smaller loan. The typical loan size there is around $1 million. Of course, the syndicated book would be multiples of that.

Operator

Our next question is from Steven Alexopoulos with JPMorgan.

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

Just 2 quick questions. First, why has the additional accretion on the acquired loans come off so much over the past 2 quarters? Is that $13 million, the new run rate we should think about?

Unknown Executive

Well, on a net basis, I mean we look at it from a net basis, where you've got your revenue minus your expenses. And they are very closely related, I believe, that ratio is about 75% or so. So of the revenue that we achieve on that, which as you point out is declining, 75% of it goes out the back door in the form of FDIC indemnification asset expense, which is in the other noninterest expense line item. So just from an overall materiality perspective, it's not impacting the numbers that much. But it's, as a function of -- what they do is they reevaluate the loans every quarter and make it -- in California, Nevada, most of it is California and they make a decision as to how much upside there is left based on performance of the quarter. And also the magnitude, the dollar amounts, dollar amounts are shrinking.

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

And just to follow up on your earlier comments of not finding attractive options for the securities portfolio. I just look at the portion of liquidity in the money market investments has moved up to 70% from 50%, a year ago quarter. I'm just wondering, at some point, do you just acknowledge that this liquidity is going to be around for a while? And even though yields aren't great, 26 basis points is on the low side and at least maybe a portion of the money market investments should be invested in something?

Unknown Executive

Yes, December 31 of this year.

Doyle L. Arnold

What he is referring to is the expiration of the TAG program. The unlimited guarantee of DDA accounts. Most of the growth in our cash can be directly related -- linked to growth in DDA accounts, 90% of that is commercial DDA and we -- there's -- and we, probably all together it's about a $5 billion increase in commercial DDA balances, and we do remain cautious that toward year end, some of those balances may leave. But yes, I don't want to make light of the fact, it is quite a pile of cash and we do continue to look for opportunities that would meet most of David's criteria at least, and not miss on any of the truly really critical, and it is difficult. But yes, we do look for non-loan ways to deploy that cash, Steve. It's just darn hard when the Fed is basically trying to force you to go 10 years, invest in equities and do -- there's not much out there that doesn't present huge duration risk, but we're doing a little.

Unknown Executive

You can be assured that we've had many lengthy discussions in the asset liability management committee on this subject. And 25 basis points isn't very high, but if you want to go out the yield curve, you can go to 2 years on treasuries and get the same things.

Harris H. Simmons

We had 26 basis points as of this morning.

Unknown Executive

That's a problem and we acknowledge it and we're trying our best to come up with something that makes sense.

Operator

The next question in queue is from Joe Morford with RBC Capital Markets.

Joe Morford - RBC Capital Markets, LLC, Research Division

Deposit costs are down 5% linked quarter mostly in the CD portfolio, which is still around 80 basis points. Just curious how you feel about your ability to continue to move those costs lower?

Doyle L. Arnold

Deposit costs?

Joe Morford - RBC Capital Markets, LLC, Research Division

Yes.

Unknown Executive

Joe, one of the things that from a CD perspective, we've still got a fair amount of room. The CD production this quarter was around 25 basis points for the new stuff. So we've got a fair amount of room to go on that front, that whole portfolios resets down, it takes about a year.

Joe Morford - RBC Capital Markets, LLC, Research Division

Okay. And then other, was just wondering if you could quantify the seasonal impact of uptick in expenses this quarter, payroll taxes, et cetera, that should come out in the second quarter?

Unknown Executive

Linked quarter was about $5 million. So that was one of the pieces there, there were some benefits and other expenses in there that account for the difference and some of the actual jump expenses was due to a slower production volume, so less of the expenses associated with that production were deferred.

Doyle L. Arnold

And do remember, Joe, we called out last quarter, that there was a $6 million or $7 million onetime expense, employee-related, benefit-related expense accrual that hit in the fourth quarter and should not have been -- should not be in your run rate.

Operator

The next question is from Ken Usdin with Jefferies & Company.

Kenneth M. Usdin - Jefferies & Company, Inc., Research Division

I wanted to ask about the other service charges line. It looks like it was down 15% or so year-over-year and there were some comments in the press release about -- would it being down a little bit on lower customer activity. But can you just talk us through just what the drivers of that are and how closely that follows production and client behavior?

Unknown Executive

Other services [indiscernible], it's Durbin. So Durbin, the year-over-year number comparison is Durbin. The linked quarter decline is actually to the point that I was making earlier about the slower production, and that was most of it.

Doyle L. Arnold

So its lower fees on new loans is what's he's describing there.

Unknown Executive

Our loan fees were down $1 million linked quarter, debit card fees were down $1.5 million. That's a seasonal consumer behavior as people spend, use their debit card a little bit less in the first quarter than they do in the fourth quarter.

Kenneth M. Usdin - Jefferies & Company, Inc., Research Division

Okay. So the commercial part wasn't that much of that decline, so it's not so much tied to the softer commercial loan side?

Unknown Executive

Right. Well and then swap fees. Swap fees was another thing that as customers take out commercial lines of credit, they will swap them, we will extend variable rate credit, generally, and they -- a lot of times they'll turn around and swap it, drop the interest rate risk exposure. That was about $2 million drop linked quarter.

Kenneth M. Usdin - Jefferies & Company, Inc., Research Division

Okay, got it. My second question is, just coming back on expenses, overall. Clearly, a lot of helpers now coming out of the credit-related side. What else is there to do or can you do just to adjust for the revenue environment. I know you talk about just being as tight as you can, but do you have any plans on trying to take out any incremental costs or are there -- is there any low-hanging fruit just to continue to make sure you're aligned to the operating environment?

Doyle L. Arnold

Harris, do you want...

Harris H. Simmons

Yes, I might. Yes, just a couple of comments. I mean I think we've worked a lot of low-hanging fruit. We've made a lot of headcount reductions over the past -- really, in the 3 years. At the same time, we've had to add, I mean, the whole the Dodd-Frank environment that we're in has required us to add a lot of people. We're up, by my kind of rough count, depending on what you include in the numbers, but if you look at risk management staffing, generally, including credit policy and administration and compliance and information security and risk management staff, review new products and do model control and internal control testing and all of that. We're up about 75% over the last 4 years. So that's where we've seen -- that's why the numbers just aren't coming down in a much more pronounced way. It's because we've essentially been offsetting other cuts with required adds. But we're working in a lot of different areas. We've seen in the last couple of years, just one example, electricity consumption in our company is down about 10% over the last couple of years. We've been able to reduce our occupancy costs and so we're working a lot of different areas. We're working right now on a major project to centralize all of our mortgage processing, back-office operations across the franchise. Something that hadn't been done before. That's a project where we're working on a longer-term project will provide us with a much more efficient set of application system that will work together, and we think lead to a lot of savings in both back and the front office. So there are variety of things that we're focused on, but there's also some new costs out there in complying with the new world we're in. All the people doing stress testing, part of that 75% increase I'm talking about. So it's just the work that will continue to go on, but I don't see anything that's going to move the needle in a major way in a short period of time.

Operator

Our final question, then, will come from Mike Turner with Compass Point.

Michael Turner - Compass Point Research & Trading, LLC

Just 2 quick ones, what's your pro forma preferred stock expense in the second quarter?

Doyle L. Arnold

That was in our 8-K and I don't have it in front of me. But if you go back and pull up the 8-K, I believe, we put it in there, did we not?

Michael Turner - Compass Point Research & Trading, LLC

I mean on a consolidated basis?

Unknown Executive

On a consolidated basis, I think it's $34 million, is the number that comes to my mind.

Michael Turner - Compass Point Research & Trading, LLC

Okay. And then just to clarify a little bit on that -- on the guidance, I guess or I'll call it guidance. I mean, you -- NII, exclusive of amortization and accelerated in regular amortization and FDIC, you still expect to be slightly down next quarter, is that -- did I understand that right?

Doyle L. Arnold

Probably slightly down in the second quarter.[indiscernible] revise quickly.

Doyle L. Arnold

Operator, I believe we're at the time limit.

Operator

Ladies and gentlemen, thank you for joining today's call. This does conclude today's program and you may now disconnect.

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