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Morningstar | Zions Likely to Increase Its Capital Return While the Bank Searches for Loan Growth

During Zions' second quarter, the bank continued to find loan growth to be elusive. Although the bank’s loans increased by 3.4% from the previous year, sequential loan growth was only 0.3%. We appreciate the bank's cautious philosophy, but we think the bank's loan growth highlights some of the challenges of being a midsize bank without a moat. The competition for new opportunities is substantial, leading Zions and similar banks to compete mostly on price. Despite Zions' struggles to increase loans, the bank saw earnings per share of $0.89, representing growth of nearly 22% from the previous year. Excluding the benefit of a lower tax rate and one-time items, Zions saw earnings per share growth of 12%. Much of that benefit resulted from strong credit quality and moderately higher yields on interest earning assets. While Zions is taking longer than we expected to reinvigorate loan growth, the company now is more than adequately capitalized and could significantly increase its dividend. Also, the bank will be getting some regulatory relief as Zions will no longer be considered a systemically important institution. Despite this positive development, we’ll be maintaining our fair value estimate of $54 per share. As of June 30, our fair value estimate is 1.5 times book value.

We do appreciate the bank is spending to hire revenue-generating employees, mentioning around 70 of the 100 employees hired in the past year were tied to revenue generation. That said, we think it’ll take time to make a meaningful contribution and expect additional staff to limit improvement in efficiency in the interim. Year to date, Zions has increased its head count by about 1.3%, following years of head count reduction. At the end of the quarter, Zions has about 700 fewer employees than it did prior to the crisis 10 years ago. In addition, on a per-employee basis, Zions is now generating more revenue on a per- employee basis than it was prior to 2008. This past quarter, annualized revenue per employee reached nearly $270,000, which is about a 10% improvement from two years ago while compensation per employee increased only 8% during that time. Given this, we think it's a good decision to invest to attract additional talent to the bank.

During the quarter, commercial real estate operations, which saw loans decline by nearly $150 million from March, held back Zions' loan growth. If CRE lending is getting more competitive, we would hope that Zions' hiring was focused on other areas such as mortgages. Mortgage lending remains one of the better performing areas for the bank. Total residential real estate loans which includes mortgages and home equity loans grew at an annualized rate exceeding 7%. In addition, municipal loans grew almost 7% from the previous quarter. If it weren’t for CRE's decline, the bank’s growth would have looked pretty good to us.

Finally, the bank ended the quarter with a common equity tier 1 ratio of 12.2%. This is meaningfully higher than what the bank requires. During the call, the bank said it was targeting capital ratios slightly higher than its peer group which have a ratio closer to 10%. If we were to assume Zions targets a common equity tier 1 ratio of 11% while holding everything else fixed, this means Zions has about $600 million in additional capital it could return to shareholders. In comparison, in 2017, the bank paid out only $129 million in dividends and repurchased $332 million in stock. This would be a significant increase to the bank’s current pace of share repurchases and dividend.

For a more in-depth take on capital returns in the banking industry and the effects of changing stress-test regulations, please see our special report titled "New Regulatory Proposals Will Change Stress Test Landscape," published on July 8.