Zions Bancorporation: Equity Raise Weighs On Valuation

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Zions Bancorporation (NASDAQ:ZION) has fallen 8% since the Federal Reserve announced that it was the only bank to fail the most recent round of stress tests, with a post-stress tier 1 capital ratio of 3.5% instead of the mandated minimum 5% (the average among all bank holding corporations was 7.6%).

Zions Bancorporation may face heightened Fed scrutiny

“Intensified regulatory scrutiny likely raises the bar for ZION’s planned capital plan resubmission,” write Sterne Agee analysts Todd L. Hagerman and Robert Greene in a March 25 report. “While the Fed seemingly took a punitive approach towards ZION’s risk profile, including potential credit risk and profitability, our sense is ZION’s planned re-submission will not only have to meet more rigorous quantitative and qualitative standards, but also meet more conservative capital standards.”

Zions Bancorporation (NASDAQ:ZION) was one of the 12 banks added to the stress tests this year, which was also the first year that the Federal Reserve used independent balance sheet projections instead of relying on projections supplied by the banks themselves. The conservative assumptions that the Fed used for the test surprised almost everyone, as internal projections were too high for many investment banks, and that’s even with the benefit of a few years’ experience.

Zions Bancorporation (NASDAQ:ZION) has said that its resubmission will include the sale of collateralized debt obligations earlier this year and other actions that it says will reduce its risk exposure, but Hagerman and Greene think there is a fair chance that the Fed will require ZION to add anywhere from $300 million to $700 million in common equity, including the reduction in CDOs on Zions Bancorporation’s balance sheet. This is on top of the time and money that will need to be spent dealing with the resubmission, creating an enormous distraction that none of Zions Bancorporation’s peers will have to face.

Common equity raise could push Zions Bancorporation’s PB ratio above peers’

While Zions Bancorporation (NASDAQ:ZION) currently trades at 1.3x tangible book compared to a median of 1.6x among its peers, that is using the capital model that failed the stress test, and Hagerman and Greene estimate that it will have a post-stress test PB closer to 1.7x. Also, its shares are already trading at 16x forward earnings along with the rest of its peers. Considering the regulatory risk that now faces the bank, they want to see a better discount for an entry point.

Hagerman and Greene rate Zions Bancorporation (NASDAQ:ZION) as Neutral with a $30 price target (currently $30.6).

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