Paul E Burdiss
Chief Financial Officer at Zions Bancorporation, National Association
Thank you, Harris. Good evening, everyone, and thank you for joining us. I'm going to start from the top. Thank you, everyone, and good evening. On slide seven, a significant highlight for us this quarter was the strong performance in average and period-end loan growth. Average non-PPP loans increased $1.5 billion or 3.1%, while period-end non-PPP loans increased $1.7 billion or 3.3% when compared to the first quarter. Areas of strength included commercial and industrial, residential mortgage, owner-occupied and home equity, as can be seen in the appendix on slide 25. The yield on average total loans increased 15 basis points from the prior quarter, which is primarily attributable to increases in interest rates. Average PPP loans declined $658 million to $801 million. Excluding PPP loans, the yield improved 18 basis points to 3.61% from 3.43%. We expect loan balances to increase at a moderate rate of growth by the second quarter of 2023. Deposit costs remain low. Shown on the right, our cost of total deposits was stable at just three basis points in the second quarter. Our average deposits declined $718 million or 0.9% linked quarter. Period-end deposits declined $3.3 billion or 4%.
A substantial portion of the runoff was attributable to large balance low-activity accounts. Some of our customers experienced merger and acquisition-related activity. While this activity is recurring, the size of some of these transactions over the past several months caused a brief influx of large deposits. And as expected, we've seen much of that money move elsewhere. As Harris noted, we have planned for and are prepared for deposit balance volatility as our customers emerge from the unusual pandemic period. Moving to slide eight. We show our securities and money market investment portfolios over the last five quarters. The size of the securities portfolio remained flat over the previous quarter as we slowed new securities purchases. Money market investments declined to $3.5 billion, reflecting the decline in period-end deposits. The combination of securities and money market investments is now 36% of total assets at period end, which remains above our pre-pandemic average of 26%. The $1.3 billion of securities purchases in the quarter had an average yield of 2.91%, which is about 80 basis points higher than the prior quarter's yield. We anticipate that securities balances will decline somewhat over the near term. Over 3/4 of our revenue is net interest income, which is significantly influenced by loan and deposit balances and associated interest rates. Slide nine is an overview of net interest income and the net interest margin. The chart on the left shows the recent 5-quarter trend for both. While the net interest margin in the white boxes has trended down over the past year, it gained 27 basis points in the current quarter. Also shown is the estimated net interest margin excluding the effect of PPP loans, which improved by about 30 basis points.
The largest contributor to improved net interest income is rising rates, combined with our asset sensitivity. As expected, our earning assets are repricing faster than our deposits, resulting in improved net interest income. Over the past year, the decline in PPP-related revenues have largely been replaced with the strategic repositioning of the securities portfolio. Slide 10 provides information about our interest rate sensitivity. The rapidly changing environment has made our traditional disclosures regarding interest rate sensitivity somewhat less useful. Therefore, we are introducing two new terms, latent interest rate sensitivity and emergent interest rate sensitivity. First, I will describe latent sensitivity. Recent increases in interest rates have not yet been fully recognized in net interest income because the balance sheet does not reprice instantaneously. Like a coiled spring, we expect these rate changes, which were in place at June 30, to work through our balance sheet and income statement over the near term. We expect this latent sensitivity to add approximately 15% to our net interest income in the second quarter of 2023 when compared to the second quarter of 2022, excluding PPP revenues. Emergent sensitivity is a more traditional view of interest rate sensitivity as it describes changes in net interest income that are expected to occur as interest rates change after the disclosure date, which in this case is June 30. We would expect the forward path of interest rates, as predicted by the yield curve at June 30, would add an additional 8% to net interest income in the second quarter of 2023 when compared to the second quarter of 2022.
Both measures assume that earning assets will remain flat and that nonspecific maturity deposits will move and reprice in accordance with our interest rate risk modeling assumptions. In other words, and for example, loan growth would be expected to add to net interest income beyond latent and emergent sensitivity estimates, which only consider changes due to rates. With respect to our traditional interest rate risk disclosures, our estimated interest rate sensitivity to a 100 basis point parallel interest rate shock has declined by about two percentage points from the first quarter. This change reflects the recent decline in deposits, an increase in our interest rate swap portfolio and a higher net interest income denominator. In summary, we expect latent and emergent interest rate sensitivity combined with continued loan growth and manageable changes in deposit volumes and pricing to meaningfully increase net interest income over the coming year. Moving on to noninterest income on slide 11. Customer-related noninterest income was $154 million, an increase of 2% over the prior quarter and 11% over the prior year. As has been noted, we have modified our overdraft and nonsufficient funds practices beginning in the third quarter. We expect these changes will reduce our noninterest income by about $5 million per quarter from the second quarter run rate. Including this reduction, our outlook for customer-related noninterest income in the second quarter of 2023 remains stable when compared to the current quarter. Noninterest expense on slide 12 was flat to the prior quarter at $464 million.
While certain seasonal first quarter items such as share-based compensation reverted to lower levels, that reduction was offset by increased base salaries. Higher base salary expense reflects the inflationary pressures of the tight labor market and an increase in staff as we invest for future growth. Incentive compensation and profit sharing accruals increased in the current quarter as our expectations have again been reset toward expanded full year PPNR and EPS growth relative to recent expectations. Our outlook for adjusted noninterest expense is to moderately increase in the second quarter of 2023 compared to the second quarter of 2022. Another significant highlight for the quarter was the continued excellent credit quality of our loan portfolio, as illustrated on slide 13. Relative to the prior quarter, we saw continued improvement in problem loans. Using the broadest definition of problem loans, the balance of criticized and classified loans dropped 7% and classified loans were down 12%. Of course, net charge-offs to average loans is the most important measure of credit quality. We had only seven basis points of annualized net charge-offs relative to average non-PPP loans in the second quarter, and the loss rate was only five basis points in the prior quarter. Shown in the chart on the bottom right, one can see the volatility of the provision for credit loss contrasted with the stability of reported net charge-offs. Slide 14 details the recent trend in our allowance for credit losses, or ACL, over the past several quarters. At the end of the second quarter, the ACL was $546 million or 1.05% of non-PPP loans.
The economic scenarios that we use to build our quantitative ACL were stable relative to the prior quarter. However, in our qualitative assessment, we increased the probability of recession. This change in outlook was the primary driver of the increase in the ACL to loan ratio. Our loss absorbing capital position is shown on slide 15. We believe that our capital position is generally well aligned with the balance sheet and operating risk of the bank. The CET1 ratio is now 9.9%. Our stated goal continues to be that the CET1 capital ratio will remain at or slightly above the peer median, which we believe positions us well for unforeseen internal or external risks. We repurchased $50 million of common stock in the second quarter. As a reminder, share repurchase and dividend decisions are made by our Board of Directors, and as such, we expect to announce any capital actions for the second quarter -- for the third quarter in conjunction with our regularly scheduled Board meeting this coming Friday. The right -- the chart on the right side of the page, 15, shows recent annualized net charge-offs as a percentage of risk-weighted assets. we have intentionally matched the scales on both charts so that you can see the order of magnitude of losses incurred during this time frame relative to the capital set aside for expected losses, the allowance for credit losses and the capital set aside for unexpected losses in the form of common equity.
Given the relatively low level of losses, we feel our capital position is appropriately strong relative to our risk profile. Slide 16 summarizes the financial outlook provided over the course of this presentation, which I will not repeat other than to point out that our outlook for net interest income refers to slide 10 for the more detailed discussion. As a reminder, this outlook represents our best current estimate for the financial performance in the second quarter of 2023 as compared to the actual results reported for the second quarter of 2022. The quarters in between are subject to normal seasonality.
This concludes our prepared remarks. Kyle, please open the line for questions.