Earnings of Zions Bancorporation, National Association (NASDAQ: ZION) surged to $1.01 per share in the third quarter, from $0.34 per share in the second quarter of 2020. The sharp earnings recovery was mostly attributable to a plunge in provision expense. Accelerated amortization of the Paycheck Protection Program fees will likely bump up earnings in the fourth quarter of this year. Further, stability in the economic outlook will lead to lower provision expense, which will likely support earnings in the coming quarters. On the other hand, pressure on asset yields will most probably hurt earnings next year. Overall, I’m expecting ZION to report earnings of $1.20 per share in the fourth quarter that will take the full-year earnings to around $2.60 per share. For 2021, I’m expecting ZION to report earnings of $3.33 per share. The June 2021 target price suggests a limited upside from the current market price; hence, I’m adopting a neutral rating on ZION.
Upcoming Loan Maturities to Pressurize Earnings Next Year
ZION’s interest income is likely to temporarily surge in the fourth quarter due to early forgiveness of Paycheck Protection Program (“PPP”) loans. As mentioned in the third quarter’s investor presentation, ZION had received applications for the forgiveness of $1.7 billion of PPP loans by the middle of October, out of total outstanding PPP loans of $6.8 billion. As a result, I’m expecting the company to accelerate the booking of fees for around 25% of PPP loans. As mentioned in the third quarter’s earnings release, PPP loans carry an average yield of 3.03%. Therefore, I’m expecting ZION to report $52 million in accelerated PPP fees in the fourth quarter.
Excluding the impact of the accelerated amortization of PPP fees, the net interest margin (“NIM”) will likely trend downwards due to pressure on asset yields following the Federal Funds rate cuts earlier this year. ZION’s loan reset/maturity profile, given in the presentation, shows that the loan portfolio has a short duration; therefore, I’m expecting a further decline in asset yields in the fourth quarter of 2020 and full-year 2021. Below is the maturity profile taken from the presentation.
The management mentioned in the third quarter’s conference call that the repricing of assets will exceed the repricing of liabilities because there’s limited opportunity to move down the costs of deposits and borrowings. As a result, the management expects the NIM to continue to decline in the near term.
On the plus side, interest rate hedges will limit the impact of rate cuts on asset yields. As mentioned in the presentation, ZION had around $5.3 billion “in-the-money” floors embedded in loans at the end of the last quarter. Considering these factors, I’m expecting the NIM to decline by 2bps in the fourth quarter from 3.06% in the third quarter. For 2021, I’m expecting the average NIM to be 19bps below the average for 2020.
Loan Growth Likely to Remain Lackluster
Due to the expected PPP loan forgiveness mentioned above, ZION’s loan balance will likely decline in the fourth quarter of 2020. The resurgence of COVID-19 cases in the United States and lockdowns in parts of Europe will likely dampen demand for credit in the commercial loan segment. Further, the management mentioned in the conference call that it expects to continue to see softness in total loan balances due to the currently low level of economic activity.
On the other hand, the residential mortgage segment will likely provide some relief because the low interest rates will drive demand even as the high unemployment rate in the country will deter some new homebuyers. The management mentioned in the presentation that the pipeline for mortgages remained strong at $1.8 billion at the end of the third quarter, up 49% year over year. However, a number of these mortgages will be resold at a gain, which will be reported as a part of non-interest income.
Considering these factors, I’m expecting ZION’s loans to decline by 3% in the fourth quarter, on a linked-quarter basis. Further, I’m expecting loans to grow at a low rate of 3% year over year in 2021, as shown in the table below.
Expecting a Lower Provision Expense, PPP to Support Earnings
The accelerated booking of PPP fees will likely drive earnings in the fourth quarter. Moreover, I’m expecting the provision expense for loan losses to decline further because ZION’s aggressive loan loss reserve build earlier this year will likely cover upcoming loan impairments. The economic outlook has remained mostly unchanged since the second quarter; therefore, I’m not expecting economic factors to drive provision expense in the coming quarters.
On the other hand, NIM compression due to asset repricing will likely hurt earnings. Considering these factors, I’m expecting ZION to report earnings of around $1.20 per share in the fourth quarter, which will take full-year earnings to $2.60 per share. For 2021, I’m expecting ZION to report earnings of $3.33 per share, as shown in the table below.
Actual earnings may differ materially from estimates because of the uncertainties related to the COVID-19 pandemic.
Based on the earnings outlook, I’m expecting ZION to maintain its quarterly dividend at the current level of $0.34 per share. The dividend estimate suggests a decent dividend yield of 4.3%.
Credit Risks have Substantially Declined
The credit risk declined significantly in the last quarter as loans requiring payment deferrals dipped to just 1% of total loans at the end of September, from 9% of total loans earlier this year, as mentioned in the earnings release.
However, some credit risk remains because of ZION’s exposure to the oil and gas sector, which had $2,445 million of loans outstanding in the third quarter, representing 4.5% of total loans. Including unfunded lending commitments, ZION’s total exposure to the oil and gas sector was $4,329 million at the end of the last quarter, as mentioned in the earnings release. The exposure to the oil and gas sector is a cause for concern because the recent surge in new COVID-19 cases globally may sap demand. In addition to the oil and gas sector, loans to COVID-19-sensitive industries, including retail and hotels, made up 8.4% of total loans at the end of the last quarter, as mentioned in the presentation.
June 2021 Target Price Suggests a Limited Upside
I’m using the historical price-to-book multiple, P/B, to value ZION. The stock has traded at an average P/B multiple of 0.81 in the first nine months of 2020. Multiplying this P/B ratio with the June 2021 forecast book value per share of $44.1 gives a target price of $35.6 for the middle of next year. This target price implies an upside of 12.7% from the stock’s October 29 closing price. The following table shows the sensitivity of the target price to the P/B multiple.
My target price of $35.6 is substantially below my previous target price because in my last report on ZION I had used an average P/B multiple of the last eight years to determine the price target. I now believe that valuations in the first half of 2021 will continue to remain stressed because of the COVID-19 pandemic. Therefore, it isn’t appropriate to consider the high P/B multiple before 2020 to determine the target price for the middle of 2021.
Based on the limited price upside implied by my new price target, I’m adopting a neutral rating on ZION.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Disclaimer: This article is not financial advice. Investors are expected to consider their investment objectives and constraints before investing in the stock(s) mentioned in the article.