Over the last year, Zions Bancorporation (NASDAQ:ZION) has provided a good gauge for regional banks and the general impact of energy loans on the financial sector. On Monday, the bank again provided an update on the energy sector after reporting Q1 earnings that could provide clues for other banks and the market in general.
The stock has rallied substantially since my last recommendation in late January that the sell off was irrational. From lows below $20 in mid-February, Zions has rebounded back to $27.50. The stock no longer provides a no brainer bargain, but the stock might still offer a value play.
The main headline is that despite deteriorating credit in the energy sector that led to a large increase in loan provisions YoY, the bank actually generated increased earnings. Zions did miss EPS estimates for Q1 by a penny. The key being that the bank keeps growing net interest income as the economy outside the energy sector actually benefits from the lower oil and natural gas costs.
The provision for loan losses nearly doubled QoQ to $42.1 million while nearly all other credit metrics deteriorated. The key though is that the exposure to energy-related loans continues to decline, thereby reducing future risk.
Source: Zions Bancorp Q1 earnings release
The above table captures that energy-related exposure declined $109 million from the December quarter, but the report doesn't capture that Zions reclassified over $200 million worth of loans outside the sector based on judgment in characterizing the borrower. The total exposure is down to only $2.6 billion of actual loans and more importantly only $2.0 in unfunded commitments that are quickly disappearing.
As the unfunded lending commitments decline, Zions is able to reduce costs by reducing the previous previsions for unfunded lending commitments. The amount declined by over $5.8 million in Q1.
With oil back over $40 per barrel, the energy exposure isn't likely to sink the bank. The real risk is anything that impacts the rest of the economy where credit performance is stellar.
The value still exists in Zions Bancorp at only slightly above $27.40 when the tangible book value is $28.20. Clearly, one is getting the stock for a fraction of TBV, but the bank is forecasted to approach $2 in EPS this year and surpass that level in 2017.
The investor takeaway is that energy exposure isn't going to take down the large regional banks. The recommendation is to purchase Zions at below book value with some capital held over for any further dips to levels substantially below TBV.
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