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Morningstar | Zions Sees Improving Growth, but Loan Growth Remains Modest

Though no-moat Zions did see a meaningful increase in earnings, the bank only saw a small acceleration in loan growth during the third quarter. We’ll remind investors that while Zions has significant potential to increase net interest margins, the company hasn’t been able to meaningfully shift its earning assets away from lower yielding securities and into loans with better yields. During the period, gross loans grew by 1.3% on a sequential basis, while year-over-year growth was just 3.8%. In the third quarter, Zions posted earnings of $1.04 per diluted share, a 44% improvement from last year’s third quarter. In part, this was aided by reserve releases as credit provisions produced a net benefit of $11 million, which provided about a five-cent boost to earnings per share. Improving credit quality also boosted net interest income as Zions was able to recoup interest earned on loans that were previously nonperforming. This and higher interest rates drove a 7-basis-point sequential improvement in NIM to 3.63% for the quarter. During the call, management said if it had excluded these one-time items, EPS growth would have been in the high-teens relative to third-quarter 2017. For now, we’ll be maintaining our fair value estimate at $56 per share. However, our thesis is partly dependent upon higher loan growth that so far has not materialized.

While Zions has been able to generate earnings growth from its exposure to short-dated securities and higher net interest margins, the bank hasn’t been able to take advantage of improving economic growth and the accompanying higher interest rates. In addition, management modestly decreased its outlook for loan growth from “modestly increasing” to “slightly to modestly increasing.” Nevertheless, this quarter’s loan growth is a small improvement from recent quarters when the company barely grew lending. Zions loan growth in the quarter came primarily from three loan segments: municipal lending, owner occupied commercial loans, and 1-4 family residential. Given management’s commentary that the bank has invested in hiring personnel dedicated to municipal lending, we’d anticipate loans to municipalities to continue to be a growth driver. However, investors should expect slower loan growth in the interim.

What we found most interesting were management’s comments on loosening standards by unregulated debt funds and capital markets borrowing. It does appear that large commercial borrowers are able to get better terms from private debt funds that often are partly funded by bank loans. Given the impressive patience Zions demonstrated since the crisis, we doubt this will cause Zions to loosen standards. However, higher competition will likely make it hard for Zions to grow in the short term. That said, in the long term, private debt funds have a higher cost of funding and increasing rates may limit debt funds ability to grow, which would benefit Zions and its peers.

Finally, credit quality continues to improve for Zions, proving 2016’s worries around the bank’s oil and gas loans were much ado about nothing. For the quarter, Zions had net recoveries on its charge-off loans. In addition, the bank’s allowance stood at 1.7 times nonaccrual loans, a substantial improvement from the previous quarter. We suspect that over the next few quarters, Zions will continue to see minimal credit provisions as the bank appears to be more than adequately reserved. However, the impact of CECL in 2019 will mean that banks have to start reserving for loan losses as loans are originated.