Zions Bancorporation (ZION 1.73%) has had, like so many other banks, a tough run over the past five years. The stock plummeted from nearly $90 per share to a low of $10 from 2007 to 2009. Since then, the bank has recovered to its current price around $29 per share.
On one hand, that's a nearly 300% improvement from 2009. On the other hand, though, that's hardly 30% of the bank's pre-crisis high.
Taking a closer look at the bank's fundamentals, there is an argument to be made that the stock is ready to continue its recovery. In the stock market nothing is ever guaranteed, but for these three reasons, I think the stock could rise.
1. The loan portfolio is healing
Banks fail when loans don't get repaid. It really is that simple, and that's why the first step in analyzing any bank is to assess the bank's loan quality.
Today, Zions Bancorp has about $427 million of non-performing assets, or NPAs, on its books. Non-performing assets are, generally speaking, loans that are severely past due and foreclosures. These represent 0.69% of the bank's total assets in what's called the "NPA ratio." For comparison, the average NPA ratio for national banks in the U.S., according to regulatory reports filed with the FDIC, is 0.88%.
The NPA ratio peaked at Zions in the first quarter of 2010 at over 5%! That means that $1 out of every $20 on the bank's books was at a very high risk to become a loss. If you were wondering why the bank's stock fell as far as it did, look no further than that ratio.
Three short years ago, the bank reported over $1.2 billion in non-performing assets. The NPA ratio at that time was 2.4%, a level that far exceeded the national average of 1.7% at the time but still represented a strong improvement from 2010.
Zions Bancorp's non-performing-assets rate. Black line is peer average. Source: BankRegData.com.
What this means for investors is that the bank is doing an exceptionally good job of cleaning up the books. The improvement from 2010 to today is exceptional.
It's critical for any investor in Zions Bancorporation to understand the assets on the books as thoroughly as possible. Today, those assets are as strong as they've been in years.
2. Zions Bancorp has plenty of dry powder ready to boost profits
When banks have troubled loans on the books, the bank is required to pull a reserve out of its income as an extra layer of protection in case that loan creates a loss in the future. If those loans later on heal or fail to realize that loss, that reserve can be released and returned to the income statement.
When that happens, banks see a short-term, but potentially strong, boost to profits. Zions Bancorp currently has a reserve of about $675 million, or about 1.7% of total loans. The bank's peer group has, on average, a reserve of just 1.4% of total loans.
Zions Bancorp's loan loss reserves with peer average. Source: BankRegData.com.
Because the bank has cleaned up its loan portfolio so effectively over the past three years, soon the bank will be able to return those excess reserves to the income statement. Because its loans are healthier and less likely to create losses, those reserves are simply no longer needed.
For context, if Zions Bancorp management decided to lower reserves to a 1.4% level to match the bank's peer set, that would release over $550 million in potential short-term profits.
To be clear, this would be a non-recurring boost only, but at the same time a potential $550 million profit boost would send a strong message to the markets.
3. Zions Bancorporation looks pretty cheap at its current price
A general rule of thumb for bank investors is that a price-to-book ratio of less than 1 represents a bargain, and higher than 3 means a bank is overpriced.
According to data from Yahoo! Finance, Zions Bancorp currently trades at a price-to-book ratio of 0.94, based on the quarter that ended June 30.
It makes sense that Zions would trade at this discount, given the problem loan issues of the past few years. However, those issues are today subsiding. The bank has a huge pile of dry powder in terms of its reserves, ready to boost profits.
In my view, the bank's upside seems to outweigh its downside risk, particularly at this valuation. One day the market will wake up and recognize figure that out, and when that day comes, I expect to see Zions Bancorporation's stock price rise.
