Zions Primed for Rising Rates

NEW YORK (TheStreet) -- Zions Bancorporation (ZION) made quite an impression on analysts at its annual investor conference last week, but not everybody's buying.

Shares of Zions Bancorporation of Salt Lake City closed at $30.90 Friday, returning 3% this year, following a 41% return during 2013. The shares trade for 1.3 times tangible book value, according to Thomson Reuters Bank Insight, and for 15.1 times the consensus 2014 earnings estimate of $2.04 a share. The consensus 2013 EPS estimate is $1.83.

That price-to-tangible book ratio is a bit low for a large regional bank, with the average among the 24 component stocks of the KBW Bank Index (I:BKX) being 1.8, however, the forward price-to-earnings ratio is rather high, when compared to an average of 12.1 for the index components.

But Zions on Thursday outlined several major areas of improvement during 2013, backing up its "base case outlook" for an increase in its return on tangible common equity to 10.3% in 2014 from 7.7% in the fourth quarter of 2013.

The company's earnings improvement during 2013 was "driven by capital actions," including the redemption of $285 million in Series B trust preferred securities paying 8.0%, $257 million in senior notes paying 7.75% and $800 million in Series C preferred stock paying 9.5%. The company also redeemed "$250 million of high cost subordinated debt."

Some of that expensive debt and equity was replaced through the issuance of $800 million in preferred stock with a weighted average dividend rate of 6.2% and $250 million in subordinated debt with a weighted average coupon of 6.1%.

Leaving aside the "$250 million of high cost subordinated debt," that was redeemed the other redemptions save the company $118.72 million a year, while the new issues cost $64.86 million, for net annual savings on dividends and interest of $53.86 million.

The interest-rate story looks good going forward, because Zions Bancorporation's balance sheet "remains significantly asset sensitive." This means that as interest rates rise -- which is expected since the Federal Reserve is curtailing its bond purchases, and will eventually begin raising the target for the federal funds rate from its current range of zero to 0.25% -- the bank's assets will reprice at higher interest rates faster than its deposits. So the net interest margin can be expected to rise faster than most peers.

KBW analyst Brian Klock on Sunday upgraded Zions to an "outperform" rating from "perform," while raising his price target for the shares to $36 from $31.00. That implies 17% upside over the next 12 months from Friday's close.  The analyst left unchanged his 2014 EPS estimate of $1.94 and is 2015 EPS estimate of $2.26, although he was already way ahead of the consensus for both. Because of the asset-sensitive position of the bank's balance sheet KBW believes the consensus estimates are "too low" for 2014 and 2014, and that "this could be a driver of stock outperformance," Klock wrote Sunday in a note to clients.

"We believe economic activity has increased in the in Utah, Texas, California and Colorado, and when combined with stability in Nevada, could help to drive mid-single-digit consolidated loan growth in the next few years," Klock added.

The company's average loans - excluding loans held for sale and acquired loans with loss-sharing guarantees from the Federal Deposit Insurance Corp - rose 4% during 2013 to $38.3 billion in the fourth quarter.

Zions reported a fourth-quarter net loss, driven by regulatory developments. The company reported a fourth-quarter net loss to common shareholders of $59.4 million, or 32 cents a share, declining from positive earnings of $209.7 million, or $1.12 a share, during the third quarter and $35.6 million, or 19 cents a share, during the fourth quarter of 2012. The third quarter results included a gain of $126 million, or 68 cents a share, from the redemption of preferred stock.

The fourth-quarter results were affected by debt extinguishment costs and an impairment charge on collateralized debit securities backed by trust preferred securities, resulting from the company's decision to pare these securities in light of the Volcker Rule, which was finalized by regulators in December, but then modified in January. Together these extraordinary items lowered fourth-quarter earnings of $222 million before tax, or 74 cents a share.

Then on Thursday, Zions announced it had sold CDOs it had "identified for sale in December," resulting in a pretax gain of $65 million, reflecting an improvement in the market value of the CDOs brought about by regulators modification to their Volcker regulations in January.

"With the sale of some of the non-qualifying CDOs in 2014 we believe the company's risk profile has improved, which could translate into the
potential for return of capital in the 2015 CCAR," Klock wrote.  CCAR stands for Comprehensive Capital Analysis and Review, which the Federal Reserve conducts each year following its annual stress tests of large banks.  This process takes place each March.

D.A. Davidson analyst Gary Tenner on Tuesday reiterated his "buy" rating for Zions, while raising his price target to $46 from $34, reflecting "an increase in our forward TBV estimate from $25.69 to $25.92 via the gain on CDO sale to be recorded in 1Q14 and an expansion in our assumed multiple to 1.4x forward [tangible book value."  In a note to clients, Tenner wrote that in last week's presentation to investors, Zions' "management was more focused on the growth opportunities, strategy, and initiatives that could drive future EPS growth and improved profitability."

Tenner called Zions Bancorporation's most recent guidance "modestly more positive," however, Sterne Agee analyst Todd Hagerman wrote in a client note on Monday, "While the company is certainly much better positioned at this juncture, the lack of meaningful near-term earnings catalysts (and subsequent profitability improvement) combined with the company's 14-15x 2015E earnings multiple leaves us on the sidelines for now."

Hagerman stuck with his "neutral" rating, estimating Zions will earn $1.90 a share this year, with EPS rising to $2.10 in 2015.

Shares of Zions Bancorporation were up slightly in morning trading to $30.91.

This chart shows the performance of Zions Bancorporation's stock against the KBW Bank Index and the S&P 500 since the end of 2011:

ZION Chart data by YCharts

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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