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“Fifth Third Bancorp, I don’t know whether a fifth or a third is how much money you had left after their quarter a year ago but this year the loss is narrowed at Fifth Third in the fiscal fourth quarter…Let’s talk about KeyCorp. A good example of what’s going on, up about 4%. They did a little better than expected. The loss was not as bad as anticipated.” — CNBC’s Squawk on the Street 1/21/2010

Two of the larger regional powers in mid-west banking are surging Thursday after reporting smaller than expected losses to close out fiscal 2009, but we see this as an opportunity for investors to cut ties with the still struggling banks. Headquartered in Cincinnati, OH Fifth Third Bancorp (NASDAQ:FITB) reported losses to shareholder totaling $160 million which compares very favorably to the $2.14 billion hit that the bank took a year ago. KeyCorp (NYSE:KEY), Fifth Third’s cross state rival based out of Cleveland, lost $258 million in the quarter which is less than half of the company’s lossFITB taken a year ago of $524 million. Fifth Third was actually able to achieve a profit for the full fiscal year thanks to a major earnings surprise from the second quarter, but consensus analysts’ expectations are calling for a loss in the year ahead at both banks.

Both banks reported seeing improving credit trends and charge offs were nowhere near as high as a year ago, but we think it is significant that both banks are increasing loan-loss reserves in anticipation of potential weakness ahead. KeyCorp stashed away $756 million in the quarter which is a greater amount than was held in reserve in the quarter a year ago and the past sequential quarter. They are now able to cover 4.31% of total loans outstanding, up from just 4% as of September 30th. Fifth Third also increased provisions for future losses by $776 million, which was $68 million greater than the amount of loans that were charged off in the past quarter. We can appreciate the renewed caution in regards to credit quality after the past few years, but it could also signal these banks are not yet sure that the asset value write-downs are over.KEY

Surely, there were some positive signs as losses narrowed because there were fewer credit issues. Also, net margin improved for both banks; FITB saw a 12 basis point hike and KEY’s net margin rose by 24 basis points. Both banks have fortified their balance sheets with secondary offerings over the past year, which should help insulate them somewhat from continued economic weakness. With that being said, we are not ready to advise buying these shares at current price levels, especially with KeyCorp trading 8% higher and Fifth Third 9% higher today as the market trades down quite a bit.

As of this week’s report we had an Overvalued rating on KEY and Fairly Valued on FITB. Fifth Third was right on the edge of being downgraded by our methodology and today’s price appreciation may cross that threshold into Overvalued territory. Both banks have been decimated by poor credit issues over the past year and have diluted earnings power through necessary capital raises. These banks are still upping their reserves in case there is further deterioration to their credit portfolio, which makes us cautious as joblessness spreads and foreclosures persist. To be sure, we think that there are less risky, more attractive stocks for value investors.

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Source: Time to Sell Key Corp and Fifth Third