Logo of jester cap with thought bubble with words 'Fool Transcripts' below it

Image source: The Motley Fool.

Zions Bancorporation (NASDAQ:ZION)
Q2 2018 Earnings Conference Call
Jul. 23, 2018 5:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to the Zions Bancorporation second-quarter 2018 earnings results webcast. At this time, all participants are in a listen-only mode. Later, we will conduct the question-and-answer session and instructions will be given at that time. [Operator instructions].

As a reminder, this conference call is being recorded.

I would now like to turn the conference over to our host for today, James Abbott, director of investor relations. You may begin.

James Abbott -- Director of Investor Relations

Thank you, Sonia, and good evening. We welcome you to this conference call to discuss our 2018 second-quarter earnings. For our agenda today, Harris Simmons, chairman and chief executive officer, will provide a brief overview of key strategic and financial objectives after which Paul Burdiss, our chief financial officer, will provide additional detail on Zions' financial condition, wrapping up with our financial outlook over the next four quarters. Additional executives with us in the room today include Scott McLean, president and chief operating officer; Ed Schreiber, chief risk officer; and Michael Morris, chief credit officer.

Referencing Slide 2, 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 dealing with forward-looking information, which applies equally to statements made during this call. A copy of the full release as well as the slide deck is available at zionsbancorporation.com. We will be referring to the slides during this call.

The earnings release, the related slide presentation and this earnings call contain several references to non-GAAP measures, including pre-provision net revenue and the efficiency ratio, which are common industry terms used by investors and financial services analysts. The use of such non-GAAP measures are believed by management to be of substantial interest to the consumers of these financial disclosures and are used prominently throughout our disclosures.

A full reconciliation of the difference between such measures and GAAP financials is provided within the published documents, and participants are encouraged to carefully review this reconciliation. We intend to limit the length of this call to one hour. During the question-and-answer section of this call, we ask you to limit your questions to one primary and one related follow-up question to enable other participants to ask questions.

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

Harris Simmons -- Chairman and Chief Executive Officer

Thank you very much, James. We welcome all of you to our call today to discuss our second-quarter results. The results of the quarter were strong, relative to year-ago results. On Slide 3, you can see the improvement in earnings to $0.89 per share, up from $0.73 in the year-ago period.

There are a couple of notable items that affected the EPS growth. First, in the year-ago period, there was about $0.05 per share of interest recoveries, which we called out at that point as somewhat unusual in nature. At least, the dollar amount of the recoveries in that quarter was unusual and indeed in the second quarter of 2018, we had only a fraction of a penny per share of that same income.

Secondly, the change in the tax rate had a materially positive impact on the earnings, relative to the year-ago period, which was worth about $0.11. Adjusting for those two items, in an effort to make results more comparable, we experienced about a 12% increase in EPS over the prior-year period. Earnings per share for the second quarter of 2018 continued the trend of strong growth with solid pre-provision net revenue growth.

Although non-interest expense was higher than expectations and we acknowledge it was somewhat higher than our outlook from a year ago, we've experienced a stronger expansion in profitability, better credit quality and stronger EPS growth than previously expected. The increase in non-interest expense is primarily due to incentive compensation, which we'll discuss in more detail later but I'll say upfront that we still expect adjusted non-interest expense to increase slightly from 2017.

Slide 4 highlights two key profitability metrics, return on assets and return on tangible common equity. We have slightly increased the leverage of the balance sheet but we expect to do more over the next several quarters. Let me take this opportunity to address our return of capital, both in the form of share repurchases and common stock dividends as well as our progress on the consolidation of our holding company with and into our bank subsidiary.

As I suspect almost all of you are aware, in May, the Economic Growth, Regulatory Relief and Consumer Protection Act was signed into law. Later, on July 6, banking regulators issued interagency guidance, which indicated Zions would no longer be part of the CCAR DFAST framework as well as other requirements referred to collectively as enhanced prudential standards, which we are no longer subject to.

Additionally, just last Wednesday, the Financial Stability Oversight Council announced the proposed decision to grant Zions' appeal for relief from the designation as a systemically important financial institution. Finally, our merger of the bank holding company with and into the bank has been approved by the Office of the Comptroller of the Currency and the FDIC. We have yet to hold a shareholder meeting. We expect to announce the date of that meeting shortly.

But once shareholders weigh in and assuming their vote is favorable, these regulatory changes should result in the merger of the holding company into the bank, combined with these regulatory changes, should result in significantly less duplication of regulatory exams as well as increased flexibility for the board and returning capital to you.

We are particularly pleased with these developments. These, combined with our goal of achieving positive operating leverage, should result in further expansion of our return on tangible common equity. We remain focused on achieving competitive returns on our assets relative to peers.

One of the real highlights of the second quarter of 2018 and really dating back more than a year now is the continued strong improvement in credit quality. On Slide 5, you'll see the strong trends depicted on the chart in the right with classified loans declining a particularly strong 31% from the year-ago period. Improvement in oil and gas loans accounted for more than 90% of the improvement over the prior year.

We experienced net credit recoveries of $12 million or 11 basis points of loans annualized. Net charge-offs through the last four quarters were only 3 basis points. We expect that credit recoveries, which were $25 million in the quarter, will remain a beneficial factor in the remaining months of 2018 and will contribute to what we expect will be a low overall rate of net charge-offs for the full year.

Additionally, as you can see from the allowance ratios, we are still maintaining a strong coverage of non-performing assets and other problem credit metrics. The allowance increased slightly from the prior quarter, entirely due to an adjustment in our qualitative factors to reflect stresses that we can see in the broad economy, such as the discussion and implementation of tariffs and the adverse impacts that can have on certain industries but that have not yet resulted in visible deterioration of our credit quality measures. Additionally, periodically, we refine our risk rating models and reflected in the second-quarter results was a modest increase to the allowance for credit loss from such a refinement.

The other major theme that has developed over the past three years is strong and relatively consistent growth in pre-provision net revenue as depicted on Slide 6. Adjusted for the items listed in the tables at the end of this slide deck or our earnings release, and also adjusting for the larger interest income recoveries, which we characterize as being interest recoveries in excess of $1 million per loan, our pre-provision net revenue increased 7% from the year-ago quarter.

As we've been saying for a while now, the growth rate of 20% plus that we had experienced for a period of time would likely slow because we had harvested the quicker fixes, including deploying cash into securities, consolidating loan and deposit operation centers and some other simplification initiatives. We've said and continue to expect the pre-provision net revenue growth rate to be in the high single digits, without giving consideration to additional interest rate increases by the Federal Open Market Committee.

We have momentum in several areas of revenue growth, including several areas of lending, such as residential mortgage, owner-occupied and municipal lending as well as trust and wealth management and other select areas within fee income. Partially offsetting those items, we've experienced a meaningful slowdown in term commercial real estate lending. As we mentioned on last quarter's earnings call, the market pricing of such loans has tightened meaningfully relative to pricing in 2017.

We've also seen some erosion of terms and conditions in the marketplace. This combination has given us some pause in aggressively pushing for growth in that portfolio. Stepping back from the details and looking toward the future, we remain comfortable about achieving our loan growth, the growth rate targets in the mid-single digits. Even with what may be relatively stable term commercial real estate balances, we've experienced success in hiring many relationship managers.

In fact, approximately two-thirds of employees added during the past year have been relationship managers or support staff required to facilitate loan and deposit growth. Although that has a near-term effect on expense growth, we are optimistic about the prospects for revenue growth from healthy loan growth.

Slide 7 is a list of our key objectives for 2018 and '19 and our commitment to shareholders. We remain focused on simplification as well as growth, which includes the balance sheet, revenue, pre-provision net revenue and earnings-per-share growth. We're committed to continuing to achieve positive operating leverage. We have momentum in many areas of revenue generation and we have an economic tailwind with rising interest rates and strong customer sentiment.

We're targeting high single-digit growth of pre-provision net revenue without the assistance of benchmark interest rate increases. We believe we've built a very strong risk management infrastructure and as such, we expect to reduce the level of volatility and credit quality and overall net charge-offs during the next downturn, whenever that may be. We continue to invest significantly in technology improvements, which includes the substantial overhaul to our core operating systems but also includes the adoption of many products that we expect will keep Zions competitive and our customers' information safe.

We remain committed to further improvement and simplification of our operational processes. Although we have already accomplished a great deal of operational and financial simplification, we believe there is still much we can accomplish, which we believe will result in an improved efficiency ratio, balance sheet profitability and better satisfaction for customers and employees.

In 2015, we indicated that we are going to be targeting much more substantial returns on capital than what could be seen at that time. As I just mentioned, there's still room for improvement, some of which should be achieved as we right size our capital structure but we've also come a long way since 2015.

Regarding returns of capital, we've increased that from approximately 20% of earnings to a ratio of approximately 90% during the past four quarters. We view an increase of balance sheet leverage is appropriate, particularly given the reduction of the risk profile of the company, the decision on the magnitude, timing and form of capital return as a board level decision. Recently, many other CCAR banks revealed the specifics of the capital plans, while in our communication, we opted to give the board the appropriate flexibility to make its decision. However, I'm comfortable in saying that we intend to raise our payout to a greater ratio than in the past and that we recognized the common equity Tier 1 ratio on particular needs to move down toward the pure median.

Finally, we remain committed to a community-centric banking approach, maintaining the local approach to banking, separate brands, etc. that have helped us to win awards, such as the best bank in Orange County, San Diego County, best bank in Nevada and various others. That is really a reflection of the satisfaction with our customers' experience and customer profile, which is particularly attractive.

With that overview, I'll turn the time over to Paul Burdiss to review some of the financials in additional detail. Paul?

Paul Burdiss -- Chief Financial Officer

Thank you, Harris, and good evening, everyone. Thanks for joining us. I'll begin Slide 8. For the second quarter of 2018, Zions' net interest income continued to demonstrate growth, relative to the prior-year period.

Excluding interest recoveries of $16 million a year ago and $1 million in the current quarter, net interest income increased $35 million to $547 million, up approximately 7%.

With respect to revenue drivers, Slide 9 shows our average loan growth of just less than 5%, relative to the year-ago period. Average deposits increased slightly from the year-ago period and increased 7% annualized from the prior quarter. Thus far, we've been able to achieve this with a relatively modest increase in deposit costs.

Slide 10 depicts year-over-year loan balance growth of about 4% point to point, with the size of the circles on the chart representing the relative size of the portfolio components. This loan growth was adversely impacted by attrition in the term CRE and national real estate loan portfolios of about $320 million. We experienced consistent growth trends in one- to four-family, owner-occupied, and home equity.

Oil and gas loans have increased modestly, resulting from a relatively strong increase in upstream and midstream loans and a more-than-$100 million decline in energy services. Municipal loan growth has also continued to be strong during the past year. We've hired a number of staff to help us grow in that area, which is focused on smaller municipalities and essential services of those cities. We've maintained strong credit quality standards and feel comfortable with that growth.

Commercial real estate, including the construction and term portfolios, declined slightly due to the reasons Harris has already articulated. And in the guidance portion of the slide, we've moved term commercial real estate to generally stable from moderate to strong. We remain comfortable with our loan growth outlook for moderate growth, which is to be interpreted as a mid-single digit annual rate of growth.

Slide 11 breaks down key rate and cost components of our net interest margin. The top line is loan yield, which increased to 4.57%, of which about 1 basis point is related to interest recoveries. Relative to the prior quarter, the yield on the securities portfolio decreased slightly, largely due to greater prepayments, particularly in our Small Business Administration loan-backed securities. Securities premium amortization in the quarter was $36 million, up from $33 million in the prior quarter.

The duration of the securities portfolio was 3.5 years at June 30, 2018, and after shocking the portfolio by increasing the yield curve 200 basis points across the curve, there was no material change to the portfolio duration in our models. The cost of total deposits and borrowed funds increased 7 basis points in the quarter to 40 basis point, resulting in a funding beta of about 25%, both for the year-over-year and linked-quarter periods. As a reminder, in this case, beta refers to the change in the cost of deposits and borrowings relative to the change in the cost of the federal funds target rate.

The total year-over-year deposit beta was about 14% and was 23% for the linked quarter, as we begin to utilize additional strategies to retain existing and attract new deposit relationships as well as bring deposits on the balance sheet that had previously been swept off into money market and other funds. Cumulatively, since the beginning of the rising rate environment, we've experienced a total deposit beta of 7%.

We still see good pricing stability and customer growth in the smaller and operational accounts, while larger dollar accounts have been the most sensitive, as one might expect. All of these elements combined to result in a net interest margin of 3.56% for the quarter, which increased 4 basis points from the year-ago period.

However excluding the interest recoveries that we've previously highlighted and the effect of corporate tax reform on fully taxable equivalent revenue and yield, the net interest margin expanded 16 basis points over the year-ago period, which reflects a NIM beta of approximately 20% or roughly 5 basis points of net interest margin expansion for each quarter-point of benchmark rate increases. We believe this may temper moderately during the next year, as competition for loans and deposits intensify.

Next, a brief review of non-interest income on Slide 12. Customer-related fees increased 3% over the prior year to $125 million. Several line items experienced a favorable improvement relative to the year-ago period, including corporate trust, loan and card fees and capital markets activities.

Non-interest expense on Slide 13 increased to $428 million from $405 million in the year-ago quarter. However, using our calculated, adjusted non-interest expense, which adjusts for items such as severance, provision for unfunded lending commitments and other similar items, non-interest expense increased $22 million to $421 million from $399 million in the year-ago period, or about 5%. A portion of the increase relates to additional compensation that we announced in conjunction with the Tax Cuts and Jobs Act, which will be paid to most employees making less than $100,000 a year.

Those items account for about $3 million of the year-over-year increase. As detailed in the press release, about $8 million is attributable to increased salary expense, which reflects annual merit and cost of living adjustments, which are generally reflected in the second quarter of each year and the increase in the number of employees, which Harris explained earlier. Incentive compensation increased $11 million, as a result of improved financial performance and the continued improvement and absolute level of credit quality.

Turning to Slide 14, the efficiency ratio was 60.9%, compared to the year-ago period of 61%, when excluding the interest recoveries previously detailed. We reiterate our commitment to achieve an efficiency ratio below 60% for the full year 2019, excluding the possible benefits of rate increases.

Finally, on Slide 15, you see our financial outlook for the next 12 months, relative to the second quarter of 2018. One note, in the interest of simplifying our tax rate disclosure, we're attempting to give an outlook for the tax rate that includes the effects of stock-based compensation. This reduced the effective tax rate by 1.4 percentage points in the second quarter. Our outlook assumes no further option exercises in the second half of the year.

In the interest of opening up the line for questions I won't read the rest of the slide to you but will be happy to take questions regarding our outlook or any other matters.

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

Questions and Answers:

Operator

[Operator instructions]. Our first question comes from Ken Zerbe of Morgan Stanley.

Ken Zerbe -- Morgan Stanley -- Analyst

I guess maybe just starting off, in terms of loan growth. Obviously, your 12-month outlook really hasn't changed. It's still moderately increasing but just I would love to kind of reconcile that with Harris's comments in the press release and in the presentation just about how things are getting more competitive in CRE? Or obviously, this quarter's loan growth looks like it was a little bit on the weaker side. Like why did it get better? Like, how, just if feels like the underlying trends are getting more negative but the guidance is not.

So I'm just trying to reconcile those pieces.

Scott McLean -- President and Chief Operating Officer

Sure, Ken. This is Scott. Harris, why don't I jump in here and then you jump on top.

Harris Simmons -- Chairman and Chief Executive Officer

Yeah. That's fine.

Scott McLean -- President and Chief Operating Officer

OK. Ken, if you would look at Slide 19, that might be a helpful way to construct a response. The top panel of Slide 19, you can see loan growth by affiliate and by type. And I would just sort of point you over to the far right-hand column, the total column and I will address the CRE term comments but let me just kind of talk about the big picture first.

We're not changing our guidance because when you look at that far right-hand column, basically C&I and owner-occupied, it's kind of $500 million of growth. It's a major component. If you drop down and you see one- to four-family at about $500 million.

You combine that with home equity, these are our kind of residential financing activities. And then drop down a little bit further and you see municipal at 500. Those are three really healthy segments. I mean, the whole portfolio is healthy but three really good pillars for growth.

And I would just add to that that energy, as we've said about a year ago, at some point, around last quarter, this quarter, we expected energy to start to grow again. It is, in fact, doing that and so we would see energy contributing.

And notwithstanding Harris's comment which was a comment about trends in the marketplace and what we're seeing and what everybody else is seeing, we think CRE will grow as well, whether it's C&D or CRE Term. So I think the major components will be the first three I highlighted. C&I and owner-occupied, which is basically C&I lending. Our residential finance business, which is one- to four-family and home equity and thirdly, municipal continuing to be a very strong business for us and I think we're going to see positive contributions from energy and CRE in general.

So I think that's why we're not changing our guidance and it's not unusual also. If you look back over the last three or four years, for us to have a couple of soft quarters in each year, I wish it weren't that way but that happens to be how we've arrived at our kind of mid-single-digit growth over the last three years.

As for the CRE Term comments that Harris was making, everybody, I think, knows that pricing in that market has gotten more competitive as non-bank lenders are taking more exposure there and terms have gotten a bit more liberal. Having said all that, we've been able to create positive momentum in that area in the past, as have we with C&D. So [indiscernible].

Harris Simmons -- Chairman and Chief Executive Officer

Can I just add? And the comment and quote were simply to point out what anybody who is going through the numbers would find, which is that CRE is where we've had some drag most notably and explaining the reasons for it. A year ago, we were actually talking about the fact that pricing had expanded there. We were seeing opportunities. It's a tougher market and we're having to be a little choosier on finding deals that make sense.

And so I don't mean to overdo that but that's where some drag has been. I'm actually quite encouraged by some of the things we're seeing in, for example, municipal, in owner-occupied where we're seeing some good growth. And so, yeah, I think we're going to be able to get to the targets we established. It's just not going to come as much from CRE as we'd expected.

Ken Zerbe -- Morgan Stanley -- Analyst

And then just as a second follow-up question. In terms of expenses, this quarter's number, whether you look at on a reported or sort of adjusted basis, is this the right level to kind of take on a go-forward basis? I mean, obviously, again, your guidance does not change or is there certain unusual items that truly will kind of get backed out, not unusual but just elevated items.

Harris Simmons -- Chairman and Chief Executive Officer

Paul, do you want to tackle that?

Paul Burdiss -- Chief Financial Officer

Yeah. Yeah. Ken, I would focus on, if I could, rather than just trying to look at the current quarter, we've identified several items that are impacting our expenses this quarter, but as you correctly point out, we haven't changed our outlook we've provided. And so, we expect to remain along that same trajectory and I would point out as I think pretty consistently what we've been saying is that, largely, our expenses are going to hopefully be in a spot or we intend for those to be in a spot where we are continuing to create positive operating leverage and you've seen our revenues grow pretty substantially over the last year.

So we are not changing our expense outlook, particularly over the next four quarters, Ken. So I would focus on that.

Operator

Thank you. Our next question comes from John Pancari of Evercore.

John Pancari -- Evercore ISI -- Analyst

On the capital deployment side, can you talk to us a little bit more about what the timing and the board decision could be? When is your board meeting and what are some of the considerations there, factoring in here? I know, Harris you mentioned you felt it was prudent to give the board the flexibility there. So what are they considering actually that, in terms of, is it the form or the timing or how can we think about?

Harris Simmons -- Chairman and Chief Executive Officer

Well, I think what I'd tell you is, they're meeting the end of next week. And so one of the reasons we didn't want to go, take this out of their hands is because we have a meeting coming up imminently. And we certainly have a proposal for them, while I suspect they will be receptive to it but from management's perspective, we'd see a continued ramp up in capital distribution. And I think I'd probably kind of leave it there but more to come very shortly.

John Pancari -- Evercore ISI -- Analyst

Is that a typically scheduled board meeting or would it ...

Harris Simmons -- Chairman and Chief Executive Officer

Yeah. It's a regularly scheduled board meeting. Yes.

John Pancari -- Evercore ISI -- Analyst

And then I'll let my follow-up also be on the same capital topic but can you just remind us of what your CET1 target is from a longer-term perspective and how do you view that in context of how quickly you'd like to get there. Thanks.

Harris Simmons -- Chairman and Chief Executive Officer

Well, I think what we've said is, I mean I've said in the past that I'd like to see it just a little north of kind of where the median is. And I do think that as we've continued to take the risk out of the balance sheet, we really have, getting close to the median is probably about where we would find ourselves generally targeting it. And that could be a little bit of a moving target in zone right but we'll have more flexibility now that we have some relief from CCAR and DFAST. We're still absolutely going to use stress testing.

We actually intend to use it more in a more robust way than we have before in the company in terms of trying to identify where risks and weaknesses are and to make sure that we feel confident about capital targets but the execution of it should be more flexible than we've seen in the past. We'll still, quite obviously, be touching base with regulators. We expect this merger to be completed, I hope, by the end of the third quarter. And that would mean concurrence from the OCC generally in terms of the direction we're going but we expect it to be a little more flexible and quarter to quarter to be able to fine-tune that a little bit.

And so that's at least how I'm thinking about it right now.

Paul, anything you'd add to that?

Paul Burdiss -- Chief Financial Officer

Yeah. I will reiterate, John, something that Harris said in his prepared remarks and that is that we expect our payout to increase relative to where it has been. And as Harris said, we've got a board meeting here in the next week or so where this will be considered but this is a very consistent story for us, John. As you know, we think we've got more capital than we need based on our own stress test results.

And we have articulated and have been articulating our belief that our capital ratio needs to be pure median plus as we consider the risks in our balance sheet. And the timing to get there will be somewhat flexible but I certainly like to think that the board would consider a path that gets us there in the kind of the near to medium term.

Operator

Thank you. Our next question comes from Ken Usdin of Jefferies.

Ken Usdin -- Jefferies -- Analyst

Paul, two balance sheet questions for you. First, on the right side of the balance here, it looks like you did start to see some of that mix shift into deposits and out of some of the higher cost wholesales funding. Can you help us understand how much of that you saw and how much more of an opportunity that can still be from here?

Paul Burdiss -- Chief Financial Officer

There was only a little bit of that this quarter and I would measure it in the sort of hundreds of millions and in the context of our balance sheet, it wasn't a really big change. I think you're talking about the thing that we've been describing previously, which is creating a product that will help to move some of our clients' off-balance sheet money back onto our balance sheet. We've seen a little bit of success there but it's still a little bit too early to see a really big meaningful impact. Does that answer your question, Ken?

Ken Usdin -- Jefferies -- Analyst

Well, do you think it can be a big meaningful impact? And is it the type of thing where you expect that you could see big take-up or is it more of a gradual type of thing?

Paul Burdiss -- Chief Financial Officer

I think the opportunity, as I think we've previously articulated is kind of in that $1 billion range but we'll see.

Ken Usdin -- Jefferies -- Analyst

And on the asset side, you mentioned the small business securities amortization, can you help us understand the yields in the securities book were down a few basis points, how much of a burden was that on the securities yield and what's just happening in terms of new money coming on versus what's rolling off underneath the surface?

Paul Burdiss -- Chief Financial Officer

Yeah. Overall, these are kind of box card numbers. Overall, the increase in the premium amortization was worth about 8 basis points on the overall securities portfolio yield. And a lot of that came from the SBA portfolio.

As a reminder, the SBA portfolio was about $2 billion, generally variable rate that is prime based but it has a kind of a 10% premium attached to it. So, relatively small changes in that prepayment rate can have fairly large changes in the premium amortization and that's what we saw this quarter. Hopefully, that answers your question.

Ken Usdin -- Jefferies -- Analyst

Well, the second part was just, what's the front book, back book doing underneath that. What are you getting new money yields versus what's rolling off, as you're investing today?

Paul Burdiss -- Chief Financial Officer

Right. The new money yields are 50 basis points better than where it is running off and it's actually better than that.

Ken Usdin -- Jefferies -- Analyst

That's really getting masked by the SBIC stuff.

Operator

Thank you. Our next question comes from Dave Rochester of Deutsche Bank.

Dave Rochester -- Deutsche Bank -- Analyst

Just a quick one on credit. The qualitative adjustment you mentioned, did I hear that was the entire amount of the provision for the quarter? And if so, did that also account for the provision for unfunded commitments as well?

Paul Burdiss -- Chief Financial Officer

No, there were several adjustments that went into that. As you correctly point out, we consider the allowance for credit losses in the aggregate. And so there was the allowance for loan lease losses and then the provision for unfunded lending commitments but that qualitative piece was just a piece of that if that's what you're asking.

Dave Rochester -- Deutsche Bank -- Analyst

Yes. And any particular areas on which you became more punitive in your models this quarter?

Paul Burdiss -- Chief Financial Officer

Well, again, on the qualitative piece, we observed macroeconomic trends. As I think we said in the press release, things for example heightened trade tensions may create stress in the portfolio or as interest rates rise, that may produce some credit stress on our borrowers. So it was things like that and again nothing gigantic but we're just in an environment where it feels like nothing can go wrong with respect to credit because credit has been so good and improving for so long. Management I think is really trying to understand where the risks are in the portfolio.

I understand what those incurred losses are in the portfolio and reserve accordingly.

Dave Rochester -- Deutsche Bank -- Analyst

So no particular product type that particularly got hit this time?

Paul Burdiss -- Chief Financial Officer

The portfolio, kind of, strictly speaking across the board, both geographically and by product continues to perform very, very well.

Operator

Thank you. Our next question comes from Steve Moss of B. Riley FBR.

Steve Moss -- B. Riley FBR -- Analyst

I want to touch on loan growth here. It was up 5% but your unfunded commitments were up 10% year over year. Wondering what's driving the difference there, whether it's customer sentiment or if it's the way originations are weighted toward municipals or construction?

Scott McLean -- President and Chief Operating Officer

This is Scott. The increase in unfunded is primarily related to our construction loan portfolio, which will bode well for fundings over the next couple of quarters. I would not say there was any other real material change.

Steve Moss -- B. Riley FBR -- Analyst

And then with regard to CECL, just wondering you have any updated thoughts on CECL and if you have any thoughts as to how it could impact your capital plans down the road.

Paul Burdiss -- Chief Financial Officer

CECL is a developing topic. I certainly like to think that the work that our team here is kind of second to none in the industry in terms of ensuring that we have the appropriate kind of models and process to be able to develop that. We're not in a position, because of the, I'm sure you're probably pretty familiar with it but because of the diversity of assumptions required, we are kind of working with regulatory agencies and industry groups to kind of understand and try to triangulate on some assumption sets that make sense in the context of what makes sense for the industry, because we're particularly worried, I'm particularly worried, about the comparability of financial results, after CECL is implemented. This diversity of assumptions is going to make a really big difference across banks.

And so our expectation is in 2019, we'll start to see a little more quantitative disclosures around this but for now, we are paying a lot of attention to it.

Operator

Our next question comes from Jennifer Demba of SunTrust.

Jennifer Demba -- SunTrust Robinson Humphrey -- Analyst

You talked about hiring relationship managers and producers over the last year. If you have this number, how many of those have you hired just in 2018, versus the comparable period last year?

James Abbott -- Director of Investor Relations

Well, maybe, I'll think that, Jennifer. This is James. One of the things that we looked at was with the revenue growth producers, meaning, relationship managers, deposit folks, treasury management and what we found is that there was a little over 100 new employees that were hired in the affiliates over the last year and about 70% of those were revenue generators or the support staff. And so it's just a very solid mix of a lot of revenue growth opportunities we think in the future from these new individuals.

Scott McLean -- President and Chief Operating Officer

Jennifer, this is Scott. I would say, there are some especially new highly experienced additions we've made in key growth markets like Dallas and Denver and those are the two that I would point out.

Jennifer Demba -- SunTrust Robinson Humphrey -- Analyst

Was there an outsized amount hired in the second quarter?

Paul Burdiss -- Chief Financial Officer

It's been an ongoing process, Jennifer, I would say. And so I think certainly some of them came on in the second quarter. We actually did see a bump-up in the month of June.

Scott McLean -- President and Chief Operating Officer

And Jennifer, the non-relationship manager sort of hires, I would characterize as principally technology related and areas related to our technology, our technology investment priorities and also information security and those kinds of areas. So that's where you would see the increases. We're continuing to find ways to economize in all of our back office activities through our simplification initiatives and so we're very specific about where we're adding people around revenue growth and technology.

Operator

Our next question comes from Gary Tenner of D.A. Davidson.

Gary Tenner -- D.A. Davidson -- Analyst

Just wanted to ask a follow-up just on loan growth, as you were pointing out, Scott, going through the Slide 19. Can you talk about just what was happening in C&I ex-oil and gas, both at Zions and Amegy year over year and at Amegy particularly, the last quarter as well?

Scott McLean -- President and Chief Operating Officer

Yeah. This is on Page 19. And I really wouldn't have a specific comment for you. There are ebbs and flows in this and I wouldn't comment about anything necessarily specific about it.

So I'm pretty familiar with both and I'm not sure there's a trend we're necessarily seeing that would be especially setting some sort of new path or trajectory. Those are two, as you know, historically strong C&I affiliates for us. So I anticipate that they will continue to be that way. And we look at owner-occupied really quite frankly as the same.

So in terms of year over year, we look at both of those lines as kind of a combined line, doesn't really change your question but we do look at them together.

Gary Tenner -- D.A. Davidson -- Analyst

And even on a sequential-quarter basis, at Amegy, if you have a shorter look back at what happened there over the last quarter. Is that's just some sort of large pay-downs and a handful of credits or, I mean, no conclusions or comments at all?

Scott McLean -- President and Chief Operating Officer

We will look into it. We can follow up with you but my guess is that there were probably several large payoffs.

Harris Simmons -- Chairman and Chief Executive Officer

I'll just add that it can fluctuate. I mean, the week to week, the number can routinely fluctuate, just in C&I, it can fluctuate kind of $100 million in any given week. And so over the course of the quarter, I mean, you'd hope that you'd see growth but there is some volatility in that over time.

Gary Tenner -- D.A. Davidson -- Analyst

And just as my follow-up, in terms of the pending merger of the holding company into the bank, in terms of cost, I know that there are some efficiencies and you will eliminate some redundancies as it relates to your exams. Are there any actual cost saves out of the gate from that or is it really a question of, sort of moving people's attention to different duties and different things within the bank?

Harris Simmons -- Chairman and Chief Executive Officer

They are going to be quite modest real cost saves in terms of kind of first order impact. I mean I think where it really comes into play is in just being able to get, some certainty over regulatory interpretations of things, having two regulators looking at the same issues often leads to quite a lot of frustration in terms of just being able to get things done. And so a lot of this is just about the regulatory economy and getting to clear answers quickly on any particular issue. I mean, sometimes, I'm sure we'll look back and say, boy, I wish maybe the Fed would have been easier on this or on the OCC.

It's not that one is better than the other or anything of that sort. It's just any time you have to two referees calling the same play, sometimes, you get a difference of opinion and it can pull things down.

Operator

Our next question comes from Steven Alexopoulos of JP Morgan.

Steven Alexopoulos -- J.P.Morgan -- Analyst

I wanted to first follow-up on John's questions on capital return. Is there any reason that you guys would need to first resolve the holding company consolidation or should improved capital return happen relatively soon after the board meeting?

Harris Simmons -- Chairman and Chief Executive Officer

Yeah. I think I expect we'll see, as I said earlier, very quickly after the board meeting, some announcements around what we expect and at least in the short term. So, no, the merger isn't something we have to wait to start creating a little better clarity around capital return.

Steven Alexopoulos -- J.P.Morgan -- Analyst

And then separately on the expense guidance for Paul, how do you define low single digit? Is this like 2 to 3 percentish? And is there an assumption for the elimination of the holding FDIC surcharge in your guidance?

Paul Burdiss -- Chief Financial Officer

It is 2% to 3% and my expectation is that and hope is that the diff will achieve its target ratio by the end of the year and that we would see some benefit from that.

Steven Alexopoulos -- J.P.Morgan -- Analyst

OK. Is that in your 4Q assumption?

Paul Burdiss -- Chief Financial Officer

It is.

Steven Alexopoulos -- J.P.Morgan -- Analyst

Can you share what that assumption is?

Paul Burdiss -- Chief Financial Officer

It's about $7 million.

Operator

Our next question comes from Erika Najarian of Bank of America.

Erika Najarian -- Bank of America Merrill Lynch -- Analyst

My first question is the flexibility in terms of your liquidity, as you're no longer have to comply with LCR or living will. Paul, if you could remind us what are your HQLA-eligible securities and given Harris's earlier remarks on balance sheet efficiency and profitability, how you can see the composition of your balance sheet evolve over time as your prudential regulatory structure has already changed?

Paul Burdiss -- Chief Financial Officer

Erika, I would remind you that the LCR was never really a constraint for us and the reason largely is the composition of our deposits. While we have a lot of commercial deposits, they're largely operational in nature and therefore received, on a relative basis, kind of favorable treatment under the LCR. Our constraint is and has been actually liquidity stress testing and while the requirement for liquidity stress testing, kind of, the official regulatory requirement and hence prudential standards is no longer applicable, we find the liquidity stress has to be a very useful management tool, hence reported on a regular basis all the way up to the board.

So in fact, I would not expect to see a big change in the way we are managing our book. I will say philosophically, the securities portfolio exists first for liquidity and second to manage interest rate risk. That's been true and that's going to continue to be true. So I do not see a change in the composition of that book.

Erika Najarian -- Bank of America Merrill Lynch -- Analyst

And my follow-up question was really on the back of Ken's line of questioning. If you could give us a sense of the deposits that you were looking to attract back to your balance sheet. How is the rate compared to your sources of finding that are available to you today, whether it's, I noticed the time deposits went up quite a bit. There is also obviously wholesale funding.

So kind of help us understand at what rate would $1 billion come on.

Paul Burdiss -- Chief Financial Officer

Yeah. I'm just going to make one real quick, Erika, follow-up on the liquidity conversation. Portfolio composition is going to be driven by changes in the rest of the balance sheet, not by changing the way we manage our liquidity. I just wanted to kind of close the loop on that.

As it relates to those kinds of alternative vehicles for our client investments, those are going to have a rate, Erika, that is frankly pretty close to market rate, a little better than. We wouldn't offer it if it weren't profitable to us but not massively profitable and nothing like we would see from the kind of a core money market or a savings account. These are going to be because they are targeted toward our larger and more sophisticated clients, they're going to have a rate that looks much more like a capital markets rate attached to it. That's true in terms of rate and beta.

Scott McLean -- President and Chief Operating Officer

Erika, this is Scott. I would just add to that that I think Paul is absolutely right. It's all going to be accretive but it really will depend over time as to how successful we are when we bring off-balance sheet funds back on, it's going to be very much, as Paul just described it but our bankers are getting much more agile and adept at attracting large pools of deposits that are not sitting in those money Market type funds. And so, if we are successful there, then we'll obviously create an even more accretive experience than just bringing off-balance sheet funds back on the balance sheet.

Paul Burdiss -- Chief Financial Officer

But the point is, we're paying for the money and we would rather pay our clients than pay others. We are a relationship driven company and we want to make sure that we kind of continue to deepen those relationships everywhere we can.

Scott McLean -- President and Chief Operating Officer

That's the main point.

Operator

Our next question comes from Geoffrey Elliott of Autonomous Research.

Geoffrey Elliott -- Autonomous Research -- Analyst

You talked about the pressure on pricing structure in Term CRE. Can you give us a bit more detail, both on the structures that you're seeing in the market that you don't like and you want to stay away from and on the pricing compression that's been taking place, just help us size that?

Michael Morris -- Chief Credit Officer

This is Michael Morris. I'll fill that one. We're seeing probably 25, 30 basis points of pricing pressure above and beyond typically where we like to go. We're seeing burn-offs of guarantees sooner during construction and sometimes early in the stabilization period.

And I would say those are two of the bigger drivers, maybe a little bit longer ammo here and there on select product types.

Harris Simmons -- Chairman and Chief Executive Officer

Geoffrey, as you know, Michael Morris is our chief credit officer.

Operator

Our next question comes from Peter Winter of Wedbush Securities.

Peter Winter -- Wedbush Securities -- Analyst

Paul, I just wanted to go back to deposit costs and I guess kind of the outlook for deposit costs for the next few quarters, as you bring more of these sweep accounts on to the balance sheet and we've got the June rate hike and most likely get a September rate hike.

Paul Burdiss -- Chief Financial Officer

Yeah. I'm not sure if there will be a June rate hike. September seems likely. The, I would not think of the overall beta of our funding to change and the reason is effectively we are replacing what would otherwise be kind of floating rate wholesale money with kind of floating rate relationship money.

So I do not expect the overall deposit beta to change. I mean, where the biggest risk for us and I think we've talked about this previously, the biggest risk for us is not necessarily our deposit rate beta. It's really in migration, particularly migration out of DDA and interest-bearing and into interest bearing.

So that's one of the leading indicators as it relates to that rate sensitivity that we're paying a lot of attention to but as I mentioned in my prepared remarks, we've experienced a kind of an overall funding beta of about 25% in the last quarter and over the last year. And our deposit betas have been lower than that. So hopefully that's helpful, that's kind of how I'm thinking about it. This is replacing wholesale money with client money with a similar sort of rate sensitivity characteristics.

Peter Winter -- Wedbush Securities -- Analyst

And then just one follow-up on the commercial real estate loan yields, they were up 25 basis points sequentially. I'm just wondering something unusual was there.

James Abbott -- Director of Investor Relations

I think the No. 1 thing is the recovery, interest recovery in the prior quarter is the No. 1 driver. This is James Abbott.

Those interest recoveries did not recur in the second quarter of '18. They were absolutely present in the second quarter of '17 and the first quarter of '18.

Michael Morris -- Chief Credit Officer

And then I would say overall, it's Michael again. Overall, construction gross loan yields are up a bit quarter over quarter.

Peter Winter -- Wedbush Securities -- Analyst

Would you say this as a good commercial real estate loan yield, going forward continuing?

Paul Burdiss -- Chief Financial Officer

Yeah. I'm trying to think of anything extraordinary. Tell you what, we'll do a little deeper dive into that. I can't think of anything that's extraordinary that's occurring in this particular quarter.

As Michael said, the composition has changed a little bit as Term CRE has shrunk a little bit this quarter and construction was up a little bit this quarter. I think there's a little bit of a composition, loan composition thing that's happening there too, but we'll look at that a little more deeply.

Operator

Our next question comes from Christopher Spahr of Wells Fargo.

Christopher Spahr -- Wells Fargo Securities -- Analyst

Related to the fee income area and other service charges and deposit service charges, kind of lackluster growth, not just this quarter but actually the past several years and if there's any way we can kind of see any kind of changes in that kind of trajectory.

Scott McLean -- President and Chief Operating Officer

Yeah. This is Scott. I think we certainly talk about the individual elements but customer fees, in general, were muted this quarter over this quarter last year, muted by about 200 basis points to growth because of an accounting change we made last year. So as we're managing the book of fee income, we're right on top of our mid-single digit growth rate.

Christopher Spahr -- Wells Fargo Securities -- Analyst

And then just the derivative of prior questions, the incentive fee that was paid this quarter related to performance, can you give us some details on what that performance entailed, whether it's on credit quality or financial performance?

Paul Burdiss -- Chief Financial Officer

Yeah. This is Paul. I'll start and invite Harris or Scott to jump in. I want to be clear that it wasn't incentive compensation that was paid this quarter.

It's accrual of incentive compensation over the course of a year. A lot of this was sort of annual compensation and our annual program that is largely predicated on the profitability of the company. So as we tried to say in our prepared remarks, our No. 1 credit quality continues to be very good and in fact better than expectations but the other is revenue growth.

We've had more, I'd say, interest rating and other increases, which have helped us increase overall revenues above and beyond what we were expecting at the beginning of the year. And I think those were the key components of that change. Harris or Scott, would you like to?

I would just add to that that, as has been noted, we continue to believe that our expense trajectory is on track for full-year sort of guidance we've given. And I think the rate of process improvement in the company and there are many projects that add to that, a lot of significant progress in that regard that's making our company a much simpler place to do business. So all of that kind of hold together is what caused us to enhance the incentive comp line a bit in this quarter.

Harris Simmons -- Chairman and Chief Executive Officer

The only thing I'd add is, it's just to remind us all that incentive comp, by its nature, is variable. And so if profitability generally isn't materializing improvements in it, we would expect to see that the trends flatten in incentive comp. So there's kind of some self-correcting element to it as well.

Operator

We do have a follow-up question from Dave Rochester of Deutsche Bank.

Dave Rochester -- Deutsche Bank -- Analyst

Thanks for taking the follow-up. Just a quick one on the adjusted expense guidance. It seems like it actually implied a little bit of a step down in the expense run rate in the back half of the year for you to hit that 3% level on the upper end of your range. So if that FDIC surcharge doesn't come down in 4Q, are there other ways you could still hit that guidance for the year or anything that can get you that $7 million in expense reduction you might need to get there?

Paul Burdiss -- Chief Financial Officer

I think Harris just talked about one of the key ones.

Harris Simmons -- Chairman and Chief Executive Officer

That's really about the biggest lever we've got here, Dave, and I don't say absolutely. It's just a fact of life is that there are a lot of different kinds of incentives, some of them are very directly tied to specific kinds of production, tempered by credit quality etc., etc., but a lot of the pool is really driven by kind of just the macro profitability trends and it goes into annual bonuses for senior people, etc., and that's going to be adjusted with care but certainly to the extent that we aren't hitting underlying kind of the trends that we're looking for, certainly, at least a piece of what's going to come out of management.

Paul Burdiss -- Chief Financial Officer

I was only going to say, in addition to that, there is a lot of kind of current moving underneath the top of the water here as it relates to expenses and I know those of you who follow us all the time and I know you do, know that while we are cutting in places, we are also investing in other places. So there are other levers I believe as it relates to kind of acceleration or decelerating some of the investments that we're making. That can help to manage that overall level of expense.

Scott McLean -- President and Chief Operating Officer

This is Scott. I want to add one final thing to punctuate Harris's comment, he's not talking in the theoretical. If you look at our last three years' financial results, you know and you can see that we took incentive compensation down, related to hitting targets that we were very specific about. So we have demonstrated, maybe better than anybody else in the industry, a willingness to do that.

So we're serious about it.

Dave Rochester -- Deutsche Bank -- Analyst

Looking out to 2019, you do have that $7 million a quarter in extra expense savings, as that surcharge drops off. So are you thinking that this low single-digit range is appropriate for next year as well?

Scott McLean -- President and Chief Operating Officer

Well, right now, we've provided an outlook for the next four quarters. So that's all sort of a corporate in there, Dave. We'll get to 2019 when we get there. We don't like to get out too far ahead of our skis.

Operator

Our next question comes from Brad Milsaps of Sandler O'Neill.

Brad Milsaps -- Sandler O'Neill and Partners -- Analyst

Hey, guys. You've addressed all my questions. I'll make it easy for you. Thank you.

Operator

Thank you. Our next question comes from Jon Arfstrom of RBC Capital Markets.

Jon Arfstrom -- RBC Capital Markets -- Analyst

This should be a quick one. Paul, you talked about trying to get your Tier 1 common to peer levels. Where would you say the peer levels are at today?

Paul Burdiss -- Chief Financial Officer

Well, we do peer reviews. If you look at our, kind of annual proxy statement, we disclose who we think our peers are. And so if you kind of go that, through that list and calculate a median capital ratio, I think you'll find it in sort of a 10.5% common equity Tier 1 range. And as we said, we wouldn't necessarily drill our capital down to that level.

We believe over time that at least in the near term, it would be sort of a pure plus kind of level.

Harris Simmons -- Chairman and Chief Executive Officer

And I'd also want to just be clear that the exercise isn't just let's aim for this, for the median. There's a lot of work we're doing behind it. So we, I think what we'd say is I think we feel pretty comfortable that with the internal stress testing we're doing, etc., I think we can feel comfortable at getting to that kind of level. I just want to be clear on the call that that's not how we go about setting the goal.

Jon Arfstrom -- RBC Capital Markets -- Analyst

And I know the Zions' way is to be methodical, I know that but it's a lot of capital to eventually return. And I'm just curious how aggressive you want to be and how aggressive you think you can be.

Harris Simmons -- Chairman and Chief Executive Officer

Well, discussion for next week with our board, as I said earlier. We are certainly leaning toward continuing to be more aggressive.

Operator

And our next question comes from Kevin Barker of Piper Jaffray.

Kevin Barker -- Piper Jaffray -- Analyst

This quarter, your cash yield is actually approaching your securities yield. And over the last couple of years, you extended the duration of your balance sheet. Is there any desire to maybe shift a little bit to maybe shorten the duration of the balance sheet in order to take advantage of some of the movements or expectations in the short end of the yield curve?

Scott McLean -- President and Chief Operating Officer

Well, I'll say that it is a kind of an ongoing part of our ALCO discussion to think about the duration of the securities portfolio. Clearly, as the yield curve flattens, when we embarked on this journey three years ago, we had a lot of cash and the yield curve was relatively steep relatively, certainly compared to now. So, as you go back and do the math, I think you'll see pretty clear that at the time and in the place, we've absolutely made the right decision to maximize that earnings stream and value for shareholders.

Now that the yield curve is a lot flatter to your point, we actually have been, as we think about buying, we've actually been buying shorter duration stuff. So for example, a year ago, we would have been had probably a heavier mix of 15-year pass-throughs and the stuff we're buying today would be shorter and we will continue to look at that duration, again given the shape of the curve and kind of what our duration dollar buys us, if you will. That's clearly something that we need to continue to talk about and we'll continue to talk about it.

Operator

Thank you. And, ladies and gentlemen, this does conclude our question and answer session. I would now like to turn the call back over to James Abbott for any closing remarks.

James Abbott -- Director of Investor Relations

Thank you, everyone, for joining our call today. We appreciate your attendance and we thank everyone for your great questions. We look forward to seeing you at a conference sometime soon. And if you have any further follow-up questions, I'll be around tonight and throughout the day tomorrow.

Thank you so much.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.

Duration: 69 minutes

Call Participants:

James Abbott -- Director of Investor Relations

Harris Simmons -- Chairman and Chief Executive Officer

Paul Burdiss -- Chief Financial Officer

Ken Zerbe -- Morgan Stanley -- Analyst

Scott McLean -- President and Chief Operating Officer

John Pancari -- Evercore ISI -- Analyst

Ken Usdin -- Jefferies -- Analyst

Dave Rochester -- Deutsche Bank -- Analyst

Steve Moss -- B. Riley FBR -- Analyst

Jennifer Demba -- SunTrust Robinson Humphrey -- Analyst

Gary Tenner -- D.A. Davidson -- Analyst

Steven Alexopoulos -- J.P.Morgan -- Analyst

Erika Najarian -- Bank of America Merrill Lynch -- Analyst

Geoffrey Elliott -- Autonomous Research -- Analyst

Michael Morris -- Chief Credit Officer

Peter Winter -- Wedbush Securities -- Analyst

Christopher Spahr -- Wells Fargo Securities -- Analyst

Brad Milsaps -- Sandler O'Neill and Partners -- Analyst

Jon Arfstrom -- RBC Capital Markets -- Analyst

Kevin Barker -- Piper Jaffray -- Analyst

More ZION analysis

This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see our Terms and Conditions for additional details, including our Obligatory Capitalized Disclaimers of Liability.

Motley Fool Transcribing has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.