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Zions Bancorporation (ZION - Analyst Report), the UT-based lender, failed to clear the first round of annual Dodd-Frank Act Stress Test (DFAST) 2014 conducted by the Federal Reserve. With Tier 1 common ratio of 3.5%, the company missed the minimum requirement of 5%.

Substantial commercial real estate losses, higher risk-weighted assets as well as lower pre-tax, pre-provision net revenue were the cited reasons behind the failure. Nevertheless, the company will be resubmitting its capital plan.

This is the first time that Zions has participated in the stress test conducted under DFAST. Except Zions all other 29 banks including Bank of America Corporation (BAC - Analyst Report), The Goldman Sachs Group, Inc. (GS - Analyst Report) and Morgan Stanley (MS - Analyst Report) cleared the stress test, which indicate an overall stabilizing economic scenario.  

The stress test is primarily conducted to identify the shock absorbing capacity of financial institutions. The hypothetical scenarios hence created are more harsh than likely.

The clearance of stress test by a bank signifies its solid financial health and strengthens the possibility of improved capital deployment activities on approval. Given these factors, does Zions’ failure ring an alarm bell for its investors?

Zions had to submit its capital plan before it began disposing certain risky collateralized debt obligation securities (CDOs) from its portfolio in January and February. The divestiture reduced the number of nonperforming CDOs by 36%, thereby improving Zions’ balance sheet position.

Therefore, on March 26, when the Fed announces the results for the second round of the stress test, it is less likely that Zions’ current capital deployment activities will be impacted. The company, as of now, disburses a regular quarterly payout of 4 cents and has no share buyback program in place.

Moreover, with the resubmission of its capital plan, Zions will expectedly clear the stress test, given the substantial reduction of risk portfolio. We believe that there are chances of the company increasing its capital deployment activities as and when approved by the Fed.

Zions currently carries a Zacks Rank #3 (Hold).

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