Since 2007, Zions Bancorporation (NASDAQ:ZION) has lost about two thirds of its stock price high from before the financial crisis. The drop was driven by massive credit quality problems that led to a huge drop in profits and return on equity.
Since then, Zions has in many ways righted the ship, evidenced by the stock nearly tripling since the bottom in 2009. Despite this improvement, Zions still has some issues that could cause the stock to fall.
Here are three of the most significant.
1. Zions Bancorporation will likely have to raise new capital
Last year, Zions failed the Federal Reserve's required annual stress test of large U.S. banks. In the test of the most distressed environment, the Feds projected larger losses than Zions management -- losses significant enough to push the bank's capital level below the Fed's minimum standard.
Based on the Fed's testing, Zions will likely have to raise $400 million in new capital to fill that void. The bank's management team disagrees with the Fed's assumptions in the calculation, but their hands are more or less tied. Instead of fighting an unwinnable battle, management has addressed the failed stress test and outlined a corrective plan repeatedly at investor conferences over the past few months (check out slide No. 6 here in this PDF for management's breakdown).
This new capital could drive the stock lower because of the dilutive effect of $400 million of outside capital. That $400 million represents about 6.8% of the bank's total market cap as of the time of this writing. Second, and perhaps even more importantly, falling short of the Fed's standards brings into question management's ability to plan for a worst case scenario and collaborate with regulators in the oversight process.
2. Zions Bancorporation's return on equity is weak
According to the FDIC's most recent Quarterly Banking Profile, the average return on equity, or ROE, for banks with total assets greater than $10 billion was 9.69%.
Zions Bancorp reported ROE of 8.23% in the second quarter of 2014, trailing its peers by nearly 150 basis points. Going back to analyze the trend, we can clearly see Zions consistently trailing the rest of the industry going back over the past three years.
Until Zions Bancorporation is able to improve profitability and raise its return on equity results, the stock is going to have a hard time moving any higher.
3. Interest rates could stay low longer than expected
Over the past few quarters, management at Zions Bancorp has repeatedly pointed to how well the bank is positioned for interest rates to rise. As of now, most analysts expect that to happen in the next 12-18 months.
The problem for Zions is that the bank's net interest margins -- that is, the profits the bank makes from deposits and loans -- have been performing gradually worse and worse over the past 12 quarters. If rates don't rise soon, that trend will likely continue.
Over the past three years, Zions' net interest margin has declined from 4.58% to 3.57% today, per the bank's quarterly filings with the FDIC. For comparison, the bank's closest 100 peers have seen stable margins over that time, declining from 3.71% to 3.67%.
As seen in the chart below, the trend is painfully clear for Zions investors. If rates don't rise soon, the bank will likely continue to fall behind its competitors, putting further pressure on the bottom line:
Zions Bancorporation has made tremendous progress since the financial crisis, primarily through the diligent rehabilitation of the bank's problem loan portfolio.
Even with that though, the stock is far from a sure thing. Those improvements have propelled the stock nearly 300% higher over the past few years, even though that rebound doesn't come close to returning the stock to it's pre-crisis highs. Zions Bancorporation will need to overcome these three headwinds to reduce the risk that its stock could fall.
Jay Jenkins has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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