Uncertainty Easing Over Zions

Erik Kobayashi-Solomon: Hi, I'm Erik Kobayashi-Solomon, editor of Morningstar's OptionInvestor. It's my great pleasure to introduce Maclovio Pina, a banking analyst at Morningstar, to talk about Zions Bancorp, a stock that we recommended back in June.

Mac, good to see you.

Maclovio Pina: Thank you for inviting me.

Kobayashi-Solomon: First off, I know that you really like Zions, and I wonder what is it about Zions that you like? What is it about their business that is attractive and allows them to fight against these huge players like Bank of America or Wells Fargo?

Pina: What they have different is that they are super-regional in the sense that they cover a lot of different states. But what they do is in each state they have their own independent brand name. So it's rather a group of eight different banks, each with its own CEO and top management team. Although most back-office operations are run centrally, so that gives them economies of scale.

Kobayashi-Solomon: So it's kind of like a "think globally, act locally" kind of thing.

Pina: Exactly, exactly. And what makes it attractive for many--especially small--businesses, is that they don't like all the alienation that they sometimes feel with the huge banks, the mass money market banks. They like to go to a bank with a local flavor, which is what Zions stresses.

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So they really build on those relationships, because they have officers that can make localized decisions. They don't have to go to somewhere else across the country to get approved and all that. So it's really about the relationships that they harvest.

Kobayashi-Solomon: You mentioned before that it's a super-regional bank. The problem that I have with Zions is the super-region that it's in. It's the sunbelt, right? And of course, they've got a lot of exposure to commercial loans; they've got a lot of exposure to real estate.

How much do you think that they have to suffer from now on? I don't think the suffering is done in that area yet.

Pina: You're right. And I definitely don't think that they've seen the worst of their loan losses. For instance, they have relatively low exposure to some of the worst-hit states, like Arizona and Nevada, where they have about 10% of their loans in each state. However, still, losses in these states amount to 50% of their actual losses.

So we can expect as those losses wash off, we'll see California and Texas losses starting to surface even more. So while we don't expect loan losses to continue at their fast increasing pace, we definitely expect them to remain elevated for some time.

Kobayashi-Solomon: Now one thing I wanted to ask you, I've been looking at Zions' price every day these days. We first talked about this in June, stock was trading at about $11, now it's trading near our call strike at $20, and our investors have made a lot of money, about 65% return since the end of June.

What do you think has really prompted this big move to the upside? Has the uncertainty around Zions really gone down so much that it warrants this big price appreciation?

Pina: I think so. The uncertainty surrounding most banks these days is their capital cushion. And during the second quarter, Zions did a lot of capital actions. They retired part of their debt. They did some one-time gains on part of the swaps that they had associated with this debt. And they did a straight equity raise, which they completed [in August].

So having a good capital cushion takes out a lot of uncertainty of future dilution via equity raises. It's not, again, that we think loan losses or the economy is getting better or that they have short-term good growth prospects, because they don't. They are exposed to many of the states that have [problems]--California with 12% unemployment, Nevada with 12.5%.

So short-term growth will be a challenge, loan losses will be a challenge. It's the uncertainty surrounding the cushion that they have to absorb those losses that started to go away.

Kobayashi-Solomon: I see.

Pina: We don't rule out completely the possibility of a future equity raise to strengthen capital if things don't get better. But a good portion of that has been at least slimmed down.

Kobayashi-Solomon: Mac, thanks a lot for coming in. I really appreciate it.

Pina: Any time. Thank you.

Kobayashi-Solomon: And thank you for joining for us. Please stop by the OptionInvestor site, where we publish regular option investment strategies based on Morningstar's fundamental research.