Zions Bancorp NA (ZION) Q2 2021 Earnings Call Transcript

Zions Bancorp NA (NASDAQ: ZION) Q2 2021 earnings call dated Jul. 19, 2021

Corporate Participants:

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

Harris H. Simmons — Chairman and Chief Executive Officer

Scott J. McLean — President and Chief Operating Officer

Paul E. Burdiss — Chief Financial Officer

Michael Morris — Executive Vice President and Chief Credit Officer

Analysts:

Ken Zerbe — Morgan Stanley — Analyst

Dave Rochester — Compass Point — Analyst

Ebrahim Poonawala — Bank of America — Analyst

Ken Usdin — Jefferies — Analyst

John Pancari — Evercore ISI — Analyst

Peter Winter — Wedbush Securities — Analyst

Chris McGratty — KBW — Analyst

Gary Tenner — D.A. Davidson — Analyst

Brad Milsaps — Piper Sandler — Analyst

David Long — Raymond James — Analyst

Steve Moss — B. Riley — Analyst

Steven Alexopoulos — JPMorgan — Analyst

Presentation:

Operator

Good afternoon, ladies and gentlemen, and welcome to the Zions Bancorporation Second Quarter 2021 Earnings Results Webcast. [Operator Instructions]

I would now like to turn the conference over to your host, Mr. Paul Abbott, Director of Investor Relations.

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

Hi. Thank you very much, Christian. It’s actually James Abbott, but thank you again. Appreciate it. Good evening, everyone, and we welcome you to this conference call to discuss our 2021 second quarter earnings.

I would like to remind you that during this call, we will be making forward-looking statements, although actual results may differ materially. We encourage you to review the disclaimer in the press release or the slide deck on Slide 2 dealing with forward-looking information and the presentation of non-GAAP measures, which apply equally to the statements made during this call. A copy of the earnings release as well as the slide deck we’ll use on this call are available at zionsbancorporation.com.

For our agenda today, Chairman and Chief Executive Officer, Harris Simmons, will provide opening remarks, followed by comments from Scott McLean, our President and Chief Operating Officer. Paul Burdiss, our Chief Financial Officer, will conclude by providing additional detail on Zions’ financial condition. With us also today are Keith Maio, our Chief Risk Officer; and Michael Morris, our Chief Credit Officer. We intend to limit the length of this call to 1 hour.

During the question-and-answer section of the call, we request that you limit your questions to one primary one and a follow-up question, if necessary, to enable other participants to ask questions.

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

Harris H. Simmons — Chairman and Chief Executive Officer

Thanks very much, James, and welcome to all of you who joined our call this evening.

Let’s start on Slide 3. We’re really pleased with the overall results of the quarter, particularly on the credit quality front where we experienced net recoveries of previously charged-off loans. We saw loan activity, excluding PPP loans, that was more encouraging and we become somewhat more optimistic about the loan growth prospects for the future.

We accelerated the purchases of securities during the quarter resulting in linked quarter growth in that portfolio in an amount that was roughly double that of the prior quarter. And we plan to continue that pace in the near-term. Deposit growth was strong with essentially all of the growth coming from non-interest bearing deposits. And despite the increase in securities purchases, our money market investments increased relative to total assets. We continue to streamline the organization allowing operational expense to remain relatively flat.

Finally, we’re very pleased to the advancement in our technology platform having rolled out a new consumer interface, both mobile and online banking, which has materially increased the functionality of our consumer digital banking platform.

Delivered earnings per share increased to $2.08 per share from $1.90 in the prior quarter. More than $120 million of our allowance for credit loss was released due to improved confidence in the economic outlook. The strong credit quality performance relative to expectations boosted returns — boosted earnings rather and in turn boosted our capital ratios. Those capital ratios are now particularly strong relative to our risk profile.

Earnings were also bolstered by a substantial net unrealized gain on an SBIC investment that went public during the quarter. And we were encouraged to with the relative stability of our non-PPP loans, which declined only 0.1% from the prior quarter. Examining the three major loan categories, our non-PPP commercial loans increased about 0.8%, which is roughly in line with the Federal Reserve’s HA data on commercial loans when excluding PPP loans.

We continue to exercise caution with commercial real estate loans and several of the property types. As such, that category only increased 0.4%. Our consumer portfolio equals about 20% of total loans and is made up primarily of residential mortgages, which declined 3.1% from the prior quarter. Although it’s notable that the rate of attrition in that portfolio slowed as the quarter progressed.

Period end deposits increased 3% or $2.3 billion. Non-interest bearing deposits accounted for a remarkable 99.7% of that increase. Since the beginning of the pandemic, our deposits have increased more than $16 billion, which is equivalent to the deposits held at our largest affiliate bank prior to the pandemic. Appropriately managing that magnitude of influx in just 18 months has been one of our highest priorities, which Paul will be addressing in his remarks.

Going to Slide 4, it reflects recent earnings per share results along with some notable items on the right that may be of interest. As previously noted, $0.25 per share in the current quarter is the after-tax recognized net gain from an investment in a small business investment company fund. One of the companies within the fund, Recursion Pharmaceuticals, underwent an IPO in April, which we described in our first quarter 10-Q. Additionally, although not shown on the page, the per share value of the reserve release was $0.56.

On Slide 5, we highlight the balance sheet profitability metrics. The very strong results were attributable to items that I previously described.

As previously noted, another significant highlight for the quarter was the credit quality of the loan portfolio, as illustrated on Slide 6. We continue to see improvements in non-performing loans and net charge-offs when compared with the prior quarter. Although not shown, special mentioned loans declined 26% from the prior quarter and the classified loan balance declined 6%. Overall, we experienced net loan recoveries of 2 basis points of non-PPP loans in the second quarter, declining from 7 basis points of net loan charge-offs in the first quarter. Shown in the chart in the bottom right, one can see the volatility of the provision contrasted with the relative stability of net charge-offs.

Turning to Slide 7, our capital levels increased significantly during the pandemic. Our Common Equity Tier 1 capital ratio increased to 11.3% from 10% at the beginning of the pandemic. We suspended share repurchases during the most uncertain period of the pandemic, while maintaining our common stock cash dividend.

We resumed buybacks in the first quarter repurchasing $50 million of our stock. We increased the amount of buybacks to $100 million in the second quarter. Although it’s premature to announce anything today, the company is well positioned to be more active in our capital management.

Now, I’m going to turn the time over to Scott McLean, our President and Chief Operating Officer, who’s going to update you on the PPP program and our technology initiatives. Scott?

Scott J. McLean — President and Chief Operating Officer

Thank you, Harris. And good evening to everyone.

Turning to Slide 8. As a precursor to discussing the Paycheck Protection Program or PPP loans, our adjusted pre-provision net revenue was $290 million in the second quarter. This is net of the effects of the previously noted IPO. You’ll notice that the bar is split into two portions. The bottom portion of the bar represents what we think are those generally recurring income, while the top portion of the bar denotes the PPNR we’ve received from PPP loans.

Of course, we recognized that income from the source will decline. Nevertheless, our ability to outperform by a factor of 3 times the industry origination of PPP loans has resulted in significant benefits to our communities as well as hundreds of thousands of individuals and families. Of course, our earnings from the PPP program have bolstered profitability during the pandemic and produced capital that ultimately benefits our shareholders. PPNR from the program has equaled $262 million so far. And there remains $137 million in capitalized income that will be realized over time.

Turning to Slides 9 and 10, these highlights our oversized performance, noting that we rank 10th overall in origination volume of PPP loans when combining both years’ results. Zions colleagues were energized to rise to the challenge of making a difference in our communities during the pandemic. Regarding forgiveness, we’re well into the process with $6 billion of applications received and $5.3 billion approved by the SPA. That leaves $4.5 billion of PPP loans on our balance sheet at quarter end. During the second quarter, an additional $2.4 billion was forgiven by the SPA, a moderate increase over the prior quarter’s rate, leading to a moderate increase in the yield of the PPP loans.

Turning to Slide 10, having noted the positive earnings impact a moment ago, this slide reflects the longer-term lasting benefit. Specifically, as a result of the laser focus of our bankers calling efforts, you see growing relationships with all 77,000 PPP recipients. These customers collectively have also contributed significantly to our deposit growth during the pandemic. More specifically, the round one 14,000 new-to-bank customers, over 50% now appear to be utilizing as per their operating accounts, a percentage that is growing nicely each quarter.

Turning to Slide 11, for those of you who have followed us for a long time, and I believe at least a handful of you on this call have followed us for more than two decades, you’ll know that we are committed to complementing our competitive advantage as a relationship-oriented bank by enabling our customers to do business faster and more simply through technology.

Many years ago, Zions’ pioneered Remote Deposit Capture, which literally required an act of Congress to enable us to provide the service to customers. Today, we continue to be encouraged with the progress made on the technology front. This year, we rolled out our new online and mobile banking system to 650,000 consumers, which was very well received by our customers and this implementation went quite well given the size of it. By early 2022, we will do the same roll out online and mobile capabilities — additional capabilities to 130,000 of our business customers. In 2023, we expect to complete the multi-phase transition to our modern core system.

As of February 2019, you will recall that we completed the replacement of our fleet core loan systems and now have virtually all of our loans on our modern core utilizing one data model. Now we will continue to provide more details on this competitive advantage. Very simply, this means that unlike all other US banks, we have a modern core operating system that greatly reduces the complexity of aging legacy industry infrastructure.

Specifically, let me just highlight a few things that you really need to know. This core architecture is real-time, parameter driven, API-enabled, cloud compatible to include higher degrees of cyber resiliency and we’ll be far more agile as we create new products and capabilities in the future. It operates with one data model, a key to being successful in the digital world. It is capable of secondary processing. So when the US market adopts this international capability and standard, it will dramatically improve how we protect and utilize customer attribute data. Additionally, it would unify the customer account opening process at our branches and online as well as being far more user friendly for our employees.

As you know, this core transformation journey has been the catalyst for simplification and modernization throughout the company and sets us up to optimize our investment as we further automate the interface between systems in the back and front office — and back and front office processes.

I’ll now turn the time over to Paul Burdiss, Chief Financial Officer, to provide additional data on our financial condition. Paul?

Paul E. Burdiss — Chief Financial Officer

Thank you, Scott. And good evening, everyone. More than three quarters of our revenue is net interest income, which is significantly influenced by loan and deposit balances and growth.

As such, I’ll begin my comments on Slide 12 with a review of those two categories. While average loans were down in the second quarter by nearly 2% when compared to the first quarter, we are starting to see slight improvement in our C&I, owner occupied, home equity and our bank card portfolio. Excluding PPP loans, average loans were down 1% from the prior quarter and down $2.4 billion or approximately 5% from the prior year period.

As Harris noted earlier and it’s worth repeating, period end loans excluding PPP loans were essentially flat from the first quarter. Within the loan portfolio, average non-PPP commercial loans were down $172 million or less than 1% from the prior quarter, while period end commercial loans increased nearly 1%.

Within the commercial real estate category, construction and land development loans increased on a period end basis by 5.4% compared to the prior quarter and term CRE declined less than 1%. Overall, the total commercial real estate portfolio grew 0.4% when compared to the prior quarter.

Average consumer loans declined $437 million or 4.1% from the prior quarter. Unlike last quarter when consumer loans were down in each category, in the second quarter, we saw growth in three categories; home equity, construction and other commercial real estate and bank card. We saw a 5.4% decline in residential mortgages when compared to the prior quarter due to continued refinancing activity although the attrition rate slowed as the quarter progressed. And in the PPP loan portfolio, we continue to see paydowns and process forgiveness totaling $2.4 billion in the quarter. The average balance of PPP loans decreased 3% compared to the prior quarter.

One final note on loan growth. Relative to periods prior to the pandemic, revolving line of credit utilization has declined several percentage points to about 34% from about 39%. Based upon the amount of revolving loan commitments, that difference explains about $1.7 billion or nearly all of the decline in non-PPP loan balances during the last 18 months. After several quarters of declining utilization, we did see a slight uptick in utilization in the second quarter relative to the first quarter.

Deposits have been the driver of the growth of the balance sheet over the past several quarters. On the right side of this page, average deposits increased 4.5% from the prior quarter, while period end deposits increased 3%. Relative to the year ago period, average deposits increased 18%. Average non-interest bearing deposits increased 8% over the prior quarter and 26% compared to the prior year period.

Our average non-interest bearing deposits are now 49% of average total deposits and, at period end, they had reached 50%. The yield on average total loans increased slightly from the prior quarter, which is attributable to the 4.56% yield on the PPP loan portfolio. Excluding PPP loans, the yield declined 2 basis points to 3.67% from 3.69% as we continue to see some pressure on pricing in most of our markets attributable, we believe, to the surplus liquidity in the marketplace. Deposit costs are low. Our cost of total deposits fell to 4 basis points in the second quarter.

On Slide 13, we show our securities and money market investment portfolios over the last five quarters. The size of the period end securities portfolio increased by about $4 billion over the past year to $19 billion, while money market investments increased $10 billion to $11.8 billion, which is now 14% of earning assets.

As Harris noted earlier, we accelerated the growth of the securities portfolio in the second quarter, adding just under $1.2 billion on average to the available for sale portfolio. We continue to exercise caution regarding duration extension risk by purchasing bonds with relatively short final maturities and keeping an eye on the duration in an upward shock scenario. In fact, we estimate that the duration of our available for sale securities book would extend by less than one-half a year in a parallel 200 basis point upward shock.

Slide 14 is an overview of net interest income and the net interest margin. The chart on the left shows the recent five quarter trend for both. The net interest margin in the white boxes has declined over the past year, reflecting the rise in excess liquidity. Average deposit growth has exceeded average loan growth by $13 billion over the past year. For the second quarter, this growth and excess liquidity is referenced in the chart on the right as a strong growth in deposits as impact of the composition of earning assets to a larger concentration in lower yielding money market and securities investments.

In the current quarter, the effect of a greater concentration of money market investments drove 7 basis points of linked quarter net interest margin compression with the slightly dilutive effects from securities being offset by a lower cost from interest-bearing deposits.

Slide 15 shows information about our interest rate sensitivity. Focusing on the upper left hand quadrant, our asset sensitivity has increased as non-interest bearing demand deposit growth is funding an increase in short-term investments. We are generally comfortable with the increase in rate sensitivity because we still believe the risk to lower rates is limited. The duration of recent deposit growth remains uncertain and adding asset duration is less appealing relative to the interest rate risk profile.

As we previously mentioned, we are marginally adding duration by increasing the size of the investment securities and interest rate swaps portfolio. The $2.7 billion of securities purchases for the quarter had an average yield of 1.65%.

On Slide 16, customer-related fees increased 5% in the quarter to $139 million. Notably, activity-based fees such as card fee and merchant services did well. Card income increased 15% over the prior quarter due to increased customer activity and spending. Additionally, capital markets activity was stronger principally from loan syndication fees and wealth management fees maintained their strong pace when compared to the prior year.

Non-interest expense shown on Slide 17 was down 2% to $428 million in the second quarter compared to the prior quarter. Adjusted non-interest expense was down 5% or $21 million to $419 million. The decrease in adjusted non-interest expense was primarily from lower seasonal employee compensation and benefits expense and lower professional services associated with PPP loan forgiveness. Adjusted non-interest expense also excludes the $9 million success fee accrual associated with the Recursion Pharmaceuticals IPO.

Slide 18 details our allowance for credit losses or ACL. In the upper left, we show the recent declining trend in the ACL to $574 million at the end of the second quarter or 1.22% of non-PPP loans. The chart in the lower right of this page shows that $103 million of the $122 million decline in the ACL was driven by an improvement in the macroeconomic forecast.

Updated outlook can be found on Slide 19. As a reminder, this is our outlook for financial performance in the second quarter of 2022 as compared to the second quarter of 2021. The quarters in between are subject to normal seasonality and my comments are subject to our earlier reference to the forward-looking statements on Slide 2.

Due to the degree of uncertainty and the timing of customers submitting requests and the SBA approving those requests, our outlook for loan growth excludes PPP loans. On the commercial loan front, our bankers are expressing optimism and we are just starting to see green shoots of loan growth. However, loan path activity is also increasing as the relatively strong valuations are leading to increased business sale activity. We are not expecting a lot of growth in commercial real estate and consumer loans again dominated by mortgages are likely to be slow to grow as long as the yield curve remains flat and the 30-year conforming mortgages are more appealing than adjustable jumbo mortgages.

Putting it all together, we are somewhat more optimistic about loan growth now than we were in April. And as such, we are modestly increasing our outlook to slightly — to moderately increasing from slightly increasing.

We expect net interest income, also excluding PPP loan revenue, to increase moderately over the next year. We expect this to be the result of continued slight compression of loan and securities yields, which will be more than offset by continued deployment of cash into term securities and a somewhat more favorable outlook for growth in non-PPP loans.

We reiterate our outlook for customer-related fees at moderately increasing. We have started to see an improvement in economic activity translating to increases in hard and small business related fees as well as loan syndication and other commercial lending related fees. We expect the wealth management revenue will continue its double-digit growth trend and mortgage banking revenue should remain generally stable.

Adjusted non-interest expense improved from the prior quarter and we expect that non-interest expense will increase slightly by the second quarter of 2022 from the $419 million reported in the quarter just ended. We remain disciplined on expense control. But as business activity and profitability increases, expenses may increase.

Reiterating my disclaimer from our April call, this outlook does not reflect a significant change in inflation from what we’ve observed over the past several years, which we believe is an emerging an increasingly important risk to our outlook.

Finally, regarding capital management, echoing Harris’s comments, we have a very strong Common Equity Tier-1 ratio now at 11.3%, particularly in the context of excellent credit performance and the results of our internal stress testing. As we consider the balance between capital ratios and our risk profile, we believe there is room for more active capital management in the near to medium-term so long as the current macroeconomic and credit trends continue to be favorable.

This concludes our prepared remarks. Christian, would you please open the line for questions?

Questions and Answers:

Operator

[Operator Instructions] Your first question is from Ken Zerbe from Morgan Stanley. Your line is open.

Ken Zerbe — Morgan Stanley — Analyst

Hi. Great. Thanks. Good evening, guys. I guess, maybe just starting off in terms of the security investments and I know you said you obviously stepped up security investments this quarter and you plan to continue at sort of this elevated pace going forward. Now obviously, I know you don’t invest in the 10-year treasury, but with yields being around 1.2% on the treasury side, like can you just talk — I worry that the securities that you’re buying are also kind of falling in yield. Can you talk about like what you couldn’t — I guess I’m saying, where do the investments that you’re investing in today or where the yielding today versus kind of what your average purchase yield was on at — in 2Q? thanks.

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

Yeah, I can answer on that. Good evening. You’re right. I mean, obviously there has been a big rally in the 10-year, we’ve seen rates fall. We don’t invest in the 10-year, as you said. Our duration is kind of in the three- to five-year sort of bucket. And we put securities on there and that’s generally where we’ve been investing in swaps as well. I will say that we — the ALCO, our Asset and Liability Management Committee tries to be somewhat thoughtful around timing. So it’s not like we’ve got an automated program where we’re buying X million dollars per day or per week. And so, in the face of dramatically falling yields, I think you’ll see us kind of slow down with the hopes that we’ll be able to make that up later on the quarter.

Ken Zerbe — Morgan Stanley — Analyst

Got it. Okay. I think that helps a little bit. Maybe just as a related follow-up. Obviously your guidance on net interest income becoming sort of moderately increasing from here seems to be the most positive change in your guidance. Is that driven by your — I guest — change his stance on investment investing in securities like it because you’re — is it going up because you’re investing more in securities or is it going because of — no change in things like your outlook for loan yields or something else? Thanks.

Harris H. Simmons — Chairman and Chief Executive Officer

Yeah. There’s a lot. Again, I’ll start on that. There is a lot mixed into that as you know the balance sheets are pretty complicated thing. But one of the things that we are observing it, I would say particularly versus a year ago, gaining confidence in and is sort of the stickiness of the deposits that are showing up on our balance sheet and all of the relationships that go on with those. Scott did a nice job of explaining how the new depositors that are coming into the bank we’re really trying to integrate them and make them as sticky as possible. And as a result, you know it feels like this balance sheet growth is a little more permanent than I would have speculated a year ago. And what all of that means is that, yeah, we can be a little more confident in how we’re investing that cash. So that’s part of it.

But the other is, as I said, there are some green shoots for loan growth, which — it’s highly speculative and a lot of things can change in the next year. But generally speaking, the optimism in our footprint really feels like it’s improving. And so, there’s an element of a little bit of you know kind of core balance sheet growth in that outlook as well.

Ken Zerbe — Morgan Stanley — Analyst

All right. Thank you.

Operator

Your next question is from Dave Rochester from Compass Point. Your line is open.

Dave Rochester — Compass Point — Analyst

Hey. Good afternoon, guys.

Harris H. Simmons — Chairman and Chief Executive Officer

Hi, Dave.

Dave Rochester — Compass Point — Analyst

Just on your NII guidance, I was just curious how much of that moderate growth is going to be driven by securities purchases versus loan growth. It sounds like you’re starting to see some green shoots on the loan growth side. If rates continue to sit here or fall further, you decide not to allocate cash to securities, what’s the risk of that NII side is [Phonetic] basically what I’m asking? Thanks.

Paul E. Burdiss — Chief Financial Officer

Yeah. Hey, Dave. I’ll start on that. You’re right. It is maybe a little rate dependent. And so, as we say, there’s a lot of things that can change the outlook. But we’ve got, as I think I said in my prepared remarks, you got over $10 billion in cash that’s basically earning the overnight rate. And so, we’ve got a lot of capacity to continue to invest.

And as I said, we’re keeping duration pretty shot. And so, the yield might not be fantastic, but it’s more than 10 or 15 basis points if we got out to three or five years. So we’re trying to be really thoughtful about how we do that. There is some rate risk attached to it and there is a risk of loan growth attached to it. What we’re trying to provide with this four-quarter outlook is sort of our best estimate based on where we stand and based on what we see of where we think things are going to be a year from now.

Dave Rochester — Compass Point — Analyst

Okay. Appreciate that. Maybe just one quick follow-up on the capital side. You guys spoke to this already. It seems like you’ve got all kinds of capacity to accelerate that buyback going into the back half of the year. I was just curious with peer capital ratios targeted to actually decline over time, I was wondering where roughly you guys see your targeted CET-1 ratio now and how quickly do you think you’re going to get there? I know you’ll cite some capital off to support loan growth, but in terms of — it just seems like you got a lot there for buybacks. Just curious how quickly you could reduce that to your new target?

Paul E. Burdiss — Chief Financial Officer

Well, I’ll start on that and Harris will provide his perspective as well. We have been saying for some time that we expect to have a sort of a slightly better than median capital position and a slightly lower than median risk profile. And that continues to be our goal. And so, as you point out, to the extent that the economy reemerges and folks kind of get back to business and capital ratios adjust, I would expect to adjust ours accordingly, although that’s going to be — the speed at which we do that is going to be subject to the Board and other approval.

Harris H. Simmons — Chairman and Chief Executive Officer

I’d agree with that. One thing I would note is, I think that we’ve got quite a lot of room right now. But I also think that as others continue to adjust targets downward, I don’t expect that we’re going to be involved in a race to the bottom in terms of how low can we take these ratios. Among other things, I look at what’s happening in the world. Commercial real estate, I think, is not at the moment. But I think as leases run off and this world kind of adjusts, I think that’s an area we’re all going to be watching really carefully. I mean, I think there’s the whole lot of risk in the world despite the fact that we’re not seeing it emerging as losses today. So, I mean, I expect it will be — we’re going to want to be a little bit conservative relative to the crowd, but there is indeed a fair amount of room there today and we’re going to be working on that.

Dave Rochester — Compass Point — Analyst

All right. Great, thanks.

Harris H. Simmons — Chairman and Chief Executive Officer

Yeah.

Operator

Your next question is from Ebrahim Poonawala from Bank of America. Your line is open.

Ebrahim Poonawala — Bank of America — Analyst

Good afternoon. I guess, just one first question on loan growth. You’ve heard from your peers as well around green shoots on loan growth. Obviously you guys had flat balances quarter-over-quarter. Just give us some color in terms of what gives you optimism that this trend that you’ve seen recently is sustainable? And would appreciate if you could put some numbers around what modest slight loan growth for the back half means.

Scott J. McLean — President and Chief Operating Officer

This is Scott McLean. I’m happy to take that. One of the things we said throughout the last couple of quarters is, when your portfolio is declining, you need to first reach a couple of flat quarters before you can start to project increases. Even though a lot of our peers project increases in the second half of the year, I think we’re just pleased that here in the second quarter, we’ve seen a flattening. We’re not experiencing the same declines. And I think that gives us optimism that we can start to move from that with growth.

We’re clearly seeing more greater activity in all of our client bases. One of the biggest things that I think will drive loan growth will just be as our small and medium-sized businesses rebuild their working capital positions. They all collectively pulled back really hard on their investment in inventory and certainly receivables. And with the inflationary pressures, supply chain pressures, you’re seeing businesses lean heavily into rebuilding inventory again as their sales are increasing. And so, this should lead to some additional utilization — increase in utilization, which we are at historic levels — historically low levels, as Paul noted.

The other thing I would comment on is that we are very actively positioning our owner-occupied financings and HELOC financings throughout the late spring and the summer months and fall months here because those two products are directly aimed at our primary client base and we think with the right structure, there’s a lot of potential demand there.

Paul E. Burdiss — Chief Financial Officer

I’d just — just to add a footnote to that. What we’re using is some reasonably aggressive introductory kind of teaser rate pricing. And that should produce some growth in those couple of portfolios, which are really important portfolios for us. So, it may in a very short-term, the volume impact will be offset by some of the rate impact. But the rates will be kidding or a lot better than the rates we’re getting on cash at the Fed. So…

Ebrahim Poonawala — Bank of America — Analyst

Got it. And just as a follow-up to that, like the two things that we’ve heard from other banks, we are sharing loan growth with customer liquidity and supply chain constraints impact on inventories. Are either of those easing? Like if you could give an update based on your customers where liquidity stands and are they seeing some easing of supply chain constraints?

Scott J. McLean — President and Chief Operating Officer

Yeah. Our customer base, just as it is for most banks and throughout the economy, they have a lot of liquidity. It’s reflected in the low utilization rates. But there is no softening in the concerns about supply chain or concerns about inflation. Those concerns are real. They’re certainly remaining steady, if not building in terms of the minds of business owners.

Ebrahim Poonawala — Bank of America — Analyst

Thank you.

Operator

Your next question is from Ken Usdin from Jefferies. Your line is open.

Ken Usdin — Jefferies — Analyst

Hey. Thanks, guys. Good afternoon. Nice to see the ongoing control of core expenses and I heard continuing to — putting forward the systems and heading towards your Phase III. As you deal with this current environment move past hopefully the COVID spend and then on to the last legs of Future Core, are we any closer to kind of seeing that turning over of expenses where you might start to net benefit? Or we still have a little bit more of the kind of build-out going underneath the surface until we get to that point where we really start to see the productivity enhancement? Thanks.

Scott J. McLean — President and Chief Operating Officer

Yeah, it’s Scott. I’ll…

Harris H. Simmons — Chairman and Chief Executive Officer

Okay. Yeah, excellent.

Scott J. McLean — President and Chief Operating Officer

Yeah, happy to address that. We’ll see a slight increase this year on our expenses related to our future core project over last year about $3 million or $4 million built into our forecast. And then, next year, we’ll actually see some softening. But in 2023, when we go live with our deposits application, that’s where we’ll see a little bit of a bump up to be followed quickly in ’24 by a pretty nice drop off. So, all in all, expenses related to technology in Future Core specifically should be very manageable in 2022. And the only reason there’s an increase in ’23 is that when you put a major system into production, it pulls forward a lot of expenses in that year. And then, there’s about a 20% fall-off in that related cost in the following year. So, there’ll be a one-year kind of increase in ’23.

And then, just the question is, how do we divert those now available technology dollars to other technologies? I’m not sure we’ll have to divert all of them to other technologies, but the demand for technology spend will probably always continue to be very high. But we certainly will be passed the elephant in the room, which is paying for a completely new core system, something the rest of the industry in its entirety has in front of it.

Ken Usdin — Jefferies — Analyst

Yeah. Got it. Thank you, Scott. And just one follow-up, Paul. You mentioned that there’s an ebb and flow between your rate sensitivity kind of moving higher because of the non-interest-bearing deposits, but then we have the current burden of just the lower near-term rates. Has anything changed with regards to your hedging strategy? And have you added any or terminated any to kind of bring forward some of that or you just kind of let it play out according to schedule even amidst this volatility we’re having now? Thank you.

Paul E. Burdiss — Chief Financial Officer

Yeah. Well, thanks for your question. We haven’t terminated anything yet. We have done that in the past, as you know. We haven’t done that. But given the recent rally, it’s certainly something we’ll be paying attention to. In terms of adding, as I noted, we added, I think, pretty significantly in the securities portfolio. We have been growing that over the course of last year by several billion dollars. I think we’re going to continue to grow that. And then, we’re also paying a lot of attention to swaps. We put on $0.5 billion of notional value of swaps in the last quarter. These are forward starting swaps and the yield curve got to kind of a level that we are a little more comfortable with. It’s backed off away from that now. But we’re certainly paying attention to kind of both of those duration adding products that is the investment portfolio in swaps as we think about managing our interest rate sensitivity position, which you correctly point out is really being driven by some pretty great deposit growth and particularly demand deposit growth.

Ken Usdin — Jefferies — Analyst

Got it, okay. Thank you, Paul.

Operator

Your next question is from John Pancari from Evercore ISI.

John Pancari — Evercore ISI — Analyst

Good afternoon. Just on the loan growth, I heard you in terms of noting some flattening base on balances in the second quarter. And I get your expectation for slightly to moderately increasing over the next 12 months. Just in terms of that inflection in terms of how should we think about loan growth resume? Are you implying that next quarter is when we should see some growth and you expect a steady strengthening from that point or is it still something that’s kind of back-end loaded on your next 12-month outlook? Thanks.

Paul E. Burdiss — Chief Financial Officer

If I could start on that one, John, as you know, we don’t — we try really hard to not to make sort of quarter-by-quarter outlook, which is why we do our sort of four quarters out. And so, I don’t want to get overly precise on timing. But as we said, we sort of saw a flattening of period end balances this quarter. That felt pretty good. We saw an uptick in utilization. That felt pretty good. So, we need some more affirming evidence, right? But I would stay focused on where we’re going to be a year from now as opposed to trying to speculate on what’s going to happen in the third quarter.

John Pancari — Evercore ISI — Analyst

Okay. That’s helpful. And then, on the — I guess, two quick things on the expense front, two-part question. One, just in terms of the completion of the core project in 2023, do you just have the timing in 2023 when do you expect that to complete if you can give us an update there? And then, separately, because I know this obviously dovetails into your expense expectations. Can you give us your updated thoughts on your long-term efficiency ratio level? I know you’re running around 59 range this quarter. Where do you see the longer-term trend for the bank as you look out? Thanks.

Scott J. McLean — President and Chief Operating Officer

This is Scott. Let me put a finer point on this core transformation expense thought. I was talking about it kind of elliptically and I’ll put a finer point on it and then toss the ball to Paul or Harris if they want to talk about longer-term efficiency ratio. But what I basically said was that our expenses for Future Core, our core transformation project, basically would be — they’re in the range of about $45 million in 2020, 2021 and they will be a little less than that in 2022. So, around that number, in terms of P&L impact, and that number will go up into the low 50%s in 2023 when we bring the system online. And then in the following year, it will drop by about $7 million, $8 million. So, those are the kind of swings we’re talking about. They’re not big dramatic swings, but they do free up dollars once we get past 2023.

And in terms of the timing in 2023, it’s not one big conversion as we bring all of our affiliates onto the deposit system. It’s multiple conversions and it will take place throughout the year. But by the time we get to the second half of ’23, we should be clear segueing.

Harris H. Simmons — Chairman and Chief Executive Officer

And then, with respect to longer-term efficiency ratios, I’d say, you got to tell me what the rate environment looks like. 25 basis points of margin is worth a couple of hundred million dollars a year to us. And that had just so changes the picture in terms of efficiency ratio that I think in the current rate environment, M&A remains what we’ve seen over the last three months, six months for a very long period of time. I think it’s going to be tough to be under — we’re probably kind of low-60%s. I hope we’re low-60%s. But with some with some movement, I personally of the belief that this inflation is not just transitory.

I mean, we’re seeing it in — and it also gets an efficiency ratio. I mean, we’re seeing it in terms of wage pressures. So we’re trying to fill up in positions. I mean it’s a really competitive labor market right now. And we’re seeing — I heard this morning an employee that got a call was hired without an interview for about a 50% increase in pay and stuff like that starting to go on. I think that what we’re going to see personally is a sustained period of inflation that’s going to lead to higher rates. And it’s going to produce better margins, kind of produce other kinds of problems along with it. But I think that it’s, in my mind, unlikely that we’re going to see this rate environment last for a very long time. But I — if it does, I think it’s going to be tough. If it doesn’t, I think we’ll see ourselves coming back into the 50%s in a sort of a more normal rate environment. I think we’d be down probably in the mid- to low-50%s. But it’s just so dependent on the rate environment. It’s hard to say.

John Pancari — Evercore ISI — Analyst

Got it. Thanks, Harris. That’s helpful.

Harris H. Simmons — Chairman and Chief Executive Officer

Yeah.

Operator

Your next question is from Peter Winter from Wedbush Securities. Your line is open.

Peter Winter — Wedbush Securities — Analyst

Great. Thanks. I wanted to talk about credit quality, which is excellent. And it’s probably some of the best in the peer group. But as you look out next year, what is a new normal for net charge-offs through the cycle with all the derisking that you guys have done?

Harris H. Simmons — Chairman and Chief Executive Officer

Well, I’ll take a stab at it. What we’ve tried to say is, the last two or three years, our aspiration is to be kind of in the best — in the top or best quartile in the industry in terms of charge-offs. And I expect that that will be the case. I mean, I — it’s hard to know exactly what that number is, although — I mean, because we’ve seen periods like this before, where we’ve had — we’re down to kind of no charge-offs or net recoveries. And you can’t do that. I’m not sure you want to do that forever. But I would expect that we’re probably going to be in the 15, 20 basis point kind of range would be something that is sort of more normal and probably kind of reflects what we’ve done with the balance sheet.

Peter Winter — Wedbush Securities — Analyst

Got it. That’s helpful. And then, just a follow-up to that. Just the allowance for credit losses dropped to 1.22% ex-PPP. And I look to the CECL day one, I think it was about 1.08%, but just given more confidence in the economic outlook and the changes to the credit risk profile, do you think that the allowance for credit losses could go below that January 1 level?

Harris H. Simmons — Chairman and Chief Executive Officer

Let’s see. Paul, do you have any thoughts about that? I look like you’re…

Paul E. Burdiss — Chief Financial Officer

Yeah. This is Paul. I’ll start with that. Under CECL, the allowance for credit losses is so heavily dependent on the economic outlook. You’ve got the two main factors of the size and underlying risk in the portfolio and then economic outlook. And what we saw this quarter was another release that was based largely on a very quickly improving economic outlook. And it is a kind of a complicated stew that we have to build every quarter. So it would be very, very speculative, I think, to say that we could get a lot lower or even go up from here just because we just don’t know.

There are so many assumptions that go into it. I know it’s a really weak probably answer relative to what you’re looking for. But the honest answer is, is that from quarter-to-quarter, we don’t know until we get there. And then we assess the risk at the end of the quarter and we build the allowance sort of loan by loan from the bottom up.

Peter Winter — Wedbush Securities — Analyst

Okay. Thanks, Paul.

Operator

Your next question is from Chris McGratty from KBW. Your line is open.

Chris McGratty — KBW — Analyst

Hey. Good afternoon. Thanks for the question. I want to go back to a comment earlier in the call about the degree of confidence in the size of the balance sheet versus a year ago. I wonder if you could elaborate that specific to the deposits. We’ve heard some of your peers talk about some of the transitory deposits that may or may not burn down over time. But just looking for a few comments to build on your comments before about the confidence of the balance sheet. Thanks.

Paul E. Burdiss — Chief Financial Officer

Yeah. I’ll start. There are a couple of things there. One, I would say, our deposit growth relative to average deposit growth looks pretty good. That is to say, it feels like our deposit growth is a little stronger. Some of that’s from new customers, some of it is from existing customers. But we do a lot of analytics. We were a part of the sort of the CCAR and LCR world for a while. And so, all of those things that we developed, we still utilize to run the business and run the bank.

And so, part of that development on liquidity stress testing was really good insights into the operating nature of our customer accounts. And what we’re seeing is new customers are using their accounts in an operating way and existing customers are continuing and are building their use of their deposit accounts in an operating way. And what that means is that they just feel more sticky. So, I would have guessed and did a year ago that deposits that were generated through the PPP program because as a reminder, all of those PPP fundings had to occur on our balance sheet, right? We put them into a deposit account drawn on our bank.

And I expected that those funds would be largely spent. In a relatively short amount of time, what we found is that our customers are far more resilient frankly than I gave them credit for. And that’s been a really great credit story as they’ve learned to balance out their cash flows in the way they run their business. But it’s also been a really good liquidity story because all of this money that I expected to be utilized in the business ended up sort of staying on the balance sheet.

And as a result, over time, here we are a year later and deposits are much higher than they were when I was originally kind of speculating on that. So it’s a long way of saying that sort of over time and experience and with some real analytics looking at the sort of operating statistics that are underlying the deposits, we are just gaining more confidence that those deposits are going to be around longer than we originally thought.

Chris McGratty — KBW — Analyst

Thank you for the color. Maybe just one housekeeping on the tax rate. Is this a good tax rate going forward in the future?

Paul E. Burdiss — Chief Financial Officer

Well, that’s highly speculative, I would say. Based on the current law, I think we’re in pretty good shape, but that could change, as you know.

Chris McGratty — KBW — Analyst

Got it. Thank you very much.

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

Hey, Christian. This is James again. I just wanted to announce that we just got a few minutes left for the call. So we’re going to switch gears into the lightning round as we call it. So we’ll just go to one question from each questioner at this point. Thank you, all.

Operator

And your next question is from Gary Tenner from D.A. Davidson. Your line is open

Gary Tenner — D.A. Davidson — Analyst

Yeah. I had a question just with regard to the energy portfolio, further decline this quarter, which I suppose it isn’t really surprised. But I’m curious how the increase in commodity prices is maybe starting to show itself, if at all, among your E&P borrowers from an exploration perspective and whether the expectation would be that cash flows are so strong at this point as they’ve delevered that they would actually draw down on lines for that purpose or that they would fund it more out of cash flow?

Scott J. McLean — President and Chief Operating Officer

Yeah. Thank you for the question. This is Scott McLean again. Clearly, the strengthening in commodity prices has helped the entire energy sector. And our balances, excluding PPP loans, are basically flat. We do think we’ll see some growth there. And — but basically, of upstream companies, you see them going back into the field, you see drilling increasing. And most of that will be funded — it will be funded partially by cash flow, but also utilization. So the partially by cash flow, but also utilization. So the debt, fundamentally. About half the banks that used to be in the energy lending industry have exited. So it will basically be bank revolvers and cash flow that they’ll fund out of. But I think we’ll see over time increases in revolving balances for upstream companies. Credit quality has obviously been improving as well. We’re seeing that and should continue to see that. So…

Operator

Your next question is from Brad Milsaps from Piper Sandler.

Brad Milsaps — Piper Sandler — Analyst

Hi. Good evening. You just addressed my question on energy. But maybe kind of looking at the portfolio more holistically, are there other areas that you guys are emphasizing or deemphasizing more than others? Harris mentioned some concerns around CRE, maybe some teaser rates around HELOC, you mentioned municipal finance in the past. Are there other areas of the loan book that you guys are maybe more or less bullish on as we kind of contemplate your loan growth guidance over the next 12 months?

Harris H. Simmons — Chairman and Chief Executive Officer

I guess one thing I talked a little bit about CRE and I mean, I expect that probably continues to grow but very, very modestly. The municipal portfolio, we’re seeing a more competitive environment out there, and that’s probably slowed us down a little bit. And so we’ll see what happens with that, but that’s been a growth driver, which I think will probably be growing at a slower pace. I think that owner-occupied commercial real estate is likely to see some decent growth. It’s something that we’re really promoting, as I mentioned before. And…

Scott J. McLean — President and Chief Operating Officer

I might just add to that, that we’ve seen multi-quarters where our 1-4 family mortgages on balance sheet have declined. These are basically jump mortgages. And we’re starting to see a mix change, again, back to originating more held for investment. I don’t know if that line will flatten this quarter or next quarter, but if you look back over the last five or six years, 25% of our loan growth has come from 1-4 family. It’s a great product for us, it’s a great business. And I think, you’ll see — we’ll see growth there again. It just may be another quarter or two before it flattens and starts to turn.

Harris H. Simmons — Chairman and Chief Executive Officer

Yeah. So those are — I was going to say just fundamentally just commercial C&I more generally as companies. I think as Scott aptly pointed out that there are a lot of opportunities for companies to be building inventory and kind of getting back to something closer to normal and I think that’s going to result in some loan demand.

Operator

Your next question is from David Long from Raymond James. Your line is open.

David Long — Raymond James — Analyst

Hi, everyone. As it relates to C&I loan growth, you discussed several external factors that may help in seeing some green shoots. But is there anything you can do internally to try to get loan growth to pick up? Is there an opportunity for you to adjust your underwriting be more aggressive on price? Anything that Zions itself can do? Just try to help reaccelerate that C&I loan growth. Thank you.

Harris H. Simmons — Chairman and Chief Executive Officer

Well, yeah, I mean, as mentioned, we’re using some kind of reasonably aggressive introductory rates. We’re trying to really take advantage of is the fact that we have a lot of very, very low cost money. And so, we’re trying to really build a book of business that will be more normally priced as we get out of a year. But we’ll start to build balances earlier than that and give us a real income pick up even at a lower introductory rate than we’re getting on cash. So that’s probably the main thing we’re doing. We’re not really relaxing underwriting. I don’t — we think that that needs to remain reasonably constant. But we are seeing opportunities to put some — to try and more aggressively price in the near-term.

Scott J. McLean — President and Chief Operating Officer

I would just add too that the secret sauce always is the amount of time your bankers spend out of their office calling on clients and our bankers are out — they’re out calling. They’ve been doing it virtually. They’re doing it more physically now. And at the end of the day, you can’t really write about it much in an analyst report. But that’s fundamentally what drives loan growth.

Michael Morris — Executive Vice President and Chief Credit Officer

This is Michael. I might add that we’ve reduced our — kind of our temporary guidance around underwriting from COVID at its peak to now something that looks more like pre-COVID underwriting. So we’re back to kind of a pre-COVID view of how to underwrite new risk.

David Long — Raymond James — Analyst

Yeah.

Operator

Your next question is from Steve Moss from B. Riley. Your line is open

Steve Moss — B. Riley — Analyst

Good afternoon. Just with the balance sheet continue to grow here and obviously you’re seeking to be on the capital management side, kind of curious as to leverage ratio went down this quarter, how low are you willing to go on that ratio with buybacks, potentially with the low to mid-7% range be acceptable to you guys?

Paul E. Burdiss — Chief Financial Officer

Sorry, the question was on the leverage ratio?

Steve Moss — B. Riley — Analyst

Yeah. Would you go down to like below to mid-7% range?

Paul E. Burdiss — Chief Financial Officer

Yes. So I’m going to give an answer that’s more complicated than your question. And the answer is that it’s a little bit dependent upon the nature of the risk of the assets that we’re putting on. So, for example, right now, we’ve got a lot of PPP loans, which we see as having little to no credit risk and a lot of basically overnight investments, which have little to no credit risk. And as a result, I think our philosophy around capitalization is that we have to hold capital that’s commensurate with the risk in the balance sheet. That’s true for the risk-adjusted ratios and it’s true for the leverage ratio. So long as there’s not a lot of incremental risk being added, I don’t think — organizationally, I don’t think we’re overly concerned with the leverage ratio ticking down a little bit from here.

Harris H. Simmons — Chairman and Chief Executive Officer

I don’t think that’s likely to become a binding constraint for us. We’ll worry about other things before we do that.

Operator

Your last question is from Steven Alexopoulos from JPMorgan. Your line is open.

Steven Alexopoulos — JPMorgan — Analyst

Hi, everybody. Thanks for taking the question. I’m curious, as it relates to COVID, is the Delta variant having any impact on confidence levels of your commercial customers yet or are they just starting to pay attention to this or not? And maybe for Michael, as it relates to your reserve, is the potential impact from Delta embedded in the economic outlook that you used this quarter to establish the reserve? Thanks.

Harris H. Simmons — Chairman and Chief Executive Officer

Yeah, go ahead, Michael. Maybe you take this.

Michael Morris — Executive Vice President and Chief Credit Officer

Yeah, I was just going to say, it might be a little too early to understand the impact to our borrowing community. But we did have a discussion about the Delta variant. We will probably have a discussion in Q3 about it. It would end up in the qualitative area of the ACL.

Harris H. Simmons — Chairman and Chief Executive Officer

Yeah. I would just say, I think I’m not sure that it’s — we can yet discern any real concern on our customers’ part about the Delta variant. Infection rates today are still about 10% or something of where they were at the very peak. So, I think with a big portion of this population vaccinated, as it starts to pick up, I think it’s going to create a real inducement for younger people to get vaccinated, I hope. And then, our hope has got to be that as we start to understand what you need to do in terms of boosters, etc, that everybody is kind of playing ball. But I don’t think it’s showing any signs at the moment of slowing down our commercial customers’ confidence in the recovery.

Operator

Thank you. I’m showing no further question at this time. I would like to turn the call back to Mr. James Abbott for closing.

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

Thank you, Christian. And thank you to all of you for joining us today. If you have any additional questions, please contact me at e-mail — at my e-mail or by phone listed on our website. Look forward to connecting with you throughout the coming months. And again, thank you for your interest in Zions Bancorporation. This concludes our call.

Operator

[Operator Closing Remarks]