Here's the Fundamental Problem With Zions Bancorporation's Stock

Over the last year, Zions Bancorporation stock has declined over 11%. That compares to the flat performance of the S&P 500. The bank trades today at just 0.73 times its book value. That's not good.

To understand why, investors need to look no farther than one number: the bank's paltry return on equity.

Zion's Bancorporation's biggest problem Over the last 12 months, Zion's reported a return on equity of 5.4%. That's half the industry average for large banks. Again, not good.

The relationship between return on equity and the stock's valuation is based on the returns shareholders expect to achieve when they invest in a stock. If a company can't produce a sufficient return on investment for shareholders, they will sell the stock and move to better alternatives. That's the fundamental problem facing Zions, and it also explains why the stock's price is below the bank's book value. The bank's profits aren't enough to justify a premium stock price, so the market has sold it down to its current level below book value.

For example, First Republic Bank, a bank with just 1.2% less total assets than Zions, reported return on equity of 10.1% over the last 12 months. It currently trades at a robust 2.2 times its book value. And, on the other hand, comparably sized CIT Group's return on equity for the same period was 5.6%, driving its valuation even lower than Zions, to 0.57 times book value.

What will it take to turn the ship around? Improving return on equity is simple in theory, but can be difficult in practice. All else being equal, Zions just needs to lower its costs and increase its revenues. The efficiency ratio is a good tool for measuring the relationship between costs and revenues at banks. It can give us an indication of just how much work needs to be done to turn profits aroundat Zions.

A lower efficiency ratio is considered to be more efficient, indicating that it takes a bank fewer costs to generate its revenue. In Zions' case, its efficiency ratio of 70% implies that it takes $0.70 in costs to generate every $1 in net revenue.

First Republic's efficiency was 61% for the same period, corresponding with its better returns on equity. The most efficient banks in the U.S. have efficiency ratios in the mid to low 50% range.

A 70% efficiency ratio is among the worst of all large regional banks:


Efficiency Ratio

Return on Equity (Last 12 months)

Zions Bancorporation



CIT Group



First Republic Bank



Industry Average*



*Industry average for U.S. banks with more than $10 billion in total assets, sourced from the FDIC's fourth-quarter 2015 Quarterly Banking Profile.

Cutting costs and hustling for revenue growth Zions' management, to its credit, is aware of the problem and is already working to correct it.

The first place to start is getting costs under control. The company is currently working through an initiative to cut $120 million in costs by the end of 2017. That project reached the halfway point in 2015, and management reports the company is on track to hit that $120 million target on schedule.

The bank's cost problem is exacerbated by problems in its energy loan portfolio stemming from today's low oil and gas prices. Management predicts that this portfolio alone could lose $75-$100 million in 2016 alone, assuming continued low commodity prices. Those loan losses are an unfortunate headwind that will hurt earnings and distract the bank's leadership from other priorities.

Second to costs are problems with Zions' top-line revenue. The bank relies heavily on its revenue from lending compared with other large regional banks. Lending is at the core of banking, but the best banks diversify their income through other, non-interest revenue streams like wealth management, insurance sales, brokerage, and so on. At Zions, 78% of the bank's revenue comes from its lending revenue stream.

Based on a sample of 59 large U.S. banks, the industry averages 68% of net revenue from interest. As banks get larger, the ratio between interest income and non-interest income tend to balance. The four U.S. megabanks and largest regional banks rely on interest income for 50% to 60% of revenues, with the remainder coming from non-interest sources.

CIT Group is a good example of a bank with similar total assets as Zions succeeding in generating large amounts of non-interest income. 73% of CIT Group's revenue comes from non-interest sources. Non-interest revenues are oftentimes high-margin businesses as well, helping CIT generate a 1.8% return on assets, 80% better than the industry average.

Zions' management touted a 4% increase in the bank's managed fee income, a metric that CEO Harris Simmons defines as "income sources we manage directly and excludes the effect of dividends, securities gains and losses and other similar sources."

It's good that the bank is focusing on increasing non-interest revenue. However, 4% is not nearly enough.

It's not pretty, but at least management is on top of these clear problems. The numbers today are not pretty. Zions has a long way to go just to catch up just to the industry average, and farther still before it can claim itself as a high-performing bank.

Image source: Company website.

However, management is saying and doing all the right things to fix this bank for the long term. CEO Simmons spent his entire opening remarks on the bank's fourth-quarter conference call addressing the exact issues laid out here. Cost problems and revenue growth were a recurring theme throughout the entire call, with executives Paul Burdiss, Scott McLean, and Simmons repeatedly beating the drum.

The bank recently finished a huge corporate reorganization and simplification under a new national bank charter. It's making meaningful investments in new technology that should drive efficiency, productivity, and take advantage of the bank's scale. The problem in the energy portfolio may end up being a cyclical, short-term problem.

I think it's still too early to call this a turnaround worth investing in right now. However, Zions is certainly moving in the right direction, and it should be on your radar this year. If management's efforts gain traction, Zions could be an attractive long-term buy at a discounted price.

The article Here's the Fundamental Problem With Zions Bancorporation's Stock originally appeared on

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