Fifth Third Bank: Drink Deeply of the Poison

Fifth Third (FITB) was a well run bank with a cult following. Now it is up on hard times. I have looked at it numerous times with an eye to buy it, but never purchased. I blogged about that here.

I was so blinded by the past glories of the company that I couldn't even make money shorting it.

The true believers, however, really drank the Kool-Aid. In 2000, it was priced it at 7 times tangible book, plus excess capital.

So now I am back having a look at Fifth Third. Investor Relations didn't return my email (which is disappointing), but so far I have positives and negatives.

The biggest negative is location. It is big in tough states, having three of its state concentrations in three of the worst five states for property foreclosure.

The second biggest problem is a huge error of judgment on behalf of the management. They spent a large part of 2007 drinking the Kool-Aid themselves, repurchasing $1.1 billion in shares at seemingly low prices during 2007 only to issue a billion in converts at even lower prices in 2008. They paid an average price above $40 a share and issued around $10.

There is a phrase for that. It's called "believing your body odor is perfume."

But at the moment, I want to accentuate the positive. There is plenty of positive - and some of it reflects well on management.

This post focuses on the origination of mortgages with negative amortization features and high loan to valuation ratios.

Fifth Third and Negative Amortization Loans

The 2007 annual report includes the following paragraph:

The Bancorp does not originate mortgage loans that permit customers to defer principal payments or make payments that are less than the accruing interest.

That tends to cheer you up in this environment.

The 2006 annual report was slightly different:

The Bancorp does not currently originate mortgage loans that permit principal payment deferral or payments that are less than the accruing interest.

The "does not currently" line also appears in the 2005 annual report.

So sometime they stopped originating that sort of loan - and they did it years before the credit crisis broke. In other words, management did not lose their minds as the others around them did.

High Loan to Valuation Mortgages

Another indication of quality management was that they slowed origination of high loan to valuation mortgages much earlier than most of their competitors. They have a category for mortgages with a loan to valuation ratio above 80 percent and no mortgage insurance. Mortgage originations for this were as follows:

• 2004: 1286 million
• 2005: 1245 million
• 2006: 679 million
• 2007: 265 million

The company slowed its origination in this category from mid-2005 and slowed it dramatically before the credit crisis hit. That reflects very well on management. Very well indeed.

So given this, I could drink the Kool-Aid. If you, dear reader, see good reasons to stop me, please let me know. I write this blog, at least in part, for the comments and emails - and I don't get enough of them.

Meanwhile: memo to IR - it's good to return phone calls and emails.

Disclosure: none

Comments

[messy]

Based on articles about FIFTH THIRD BANK...i have concluded that the dumbest bankers are running the USA BANKS. WHY? Because they all used the flawed software and they all drank from the same cup called...subprime mortgages. They are bought their own companies stock at inflated prices,,,only to see it drop 40 to 60% in price. How stupid can a CEO GET IS THE QUESTION.

[avcacio]

John - With multiple banks falling to multi-year lows at this time, I would feel much better to be buying those banks that have "current" insider buying.

FITB has "none" in the last 3 months... even with it's price 50% lower that it was 3 months ago. For that reason, I would wait, as there are many other banks that are indeed buying their own shares at these levels.

[gmodon]

Article and 1st comment dead on w.r.t. CEO and "peter principle". Too much golf and not enough hard work by the management yields temped results. The problem starts in Congress; write your state reps. and request simple legislation connecting publically traded company management's pay and all of their compensation to shareholder returns, with retroactive repayment if previous years of the company books have to be refigured due to accounting errors. This simple task would add a huge sense of clarity in redefining the work ethic of upper management. Privately held companies can do what they want, it their risks and rewards.

[OJO Zafado]

We see the '12 & '13 maturity FITB bonds showing up on the block with the same YTM as WaMu , Morgan Stanley(some debt just downgraded), Capital One and even AIG subsidiaries like International Lease Finance (airliner leasing)& American General Financing. It seems quite unlikely that all the characters in this on going fiasco are going to be survivors. It is then left to figure out which will go the route of Bear Stearns and be rescued at a higher price than they are at now or continue down the road to oblivion wiping out their investors. The C-PrM recently went out at +8% and is now down in price to yield +9%. Here is perhaps the nation's most international bank franchise with their global platform, teetering? The Fed's response? Hold until relieved. The markets late in the week showed their distain for the current economic policies of Bush and his gangsters. We are squarely lodged in a stagflation. The real world of US finance is transforming itself into an Orwellian one. Based on how the FITB bonds are trading the picture for FITB looks bleak. It would seem too early still to get into these banking shares until a few actually go under and we see who the survivors will be. While the Bank of New England went under in 1990 the Bank of Boston traded down into the single digits. If you waited for the Bank of New England to fail before buying Bank of Boston you would have done quite nicely. Every time it is different. This time we may be heading for a more persistent inflationary spiral than we saw in the post Vietnam War era. This time we have destroyed the dollar by fighting a war of mass deception with over a trillion dollars of electronic funds. While saving the taxpayers money on printing costs the profligacy continues by the Fed. 100s of Billions every month in TAFs and TRCAs on top of guaranteeing tottering investment banks. The elected politicians still pandering to the electorate as massive spending deficits loom in the "near years" for Medicare and Social Security. We now have Republicans running for office as "candidate for". You won't know they are Republicans unless you look very closely at their campaign materials. No union label watermark! They are outed! The Democrats are just as bad criticizing the massive budget deficits but promising not to raise taxes to pay for anything either. Nothing will come out of Washington in the next 6 months to stop the insanity of these fools that the American people elected and now so richly deserve. It seems quite clear no action or intervention will take place before the Election to save the value of the US dollar. This means oil, other energy,gold, and agribusiness related will soar even as the Dow makes it's way to 10,000. That should happen by Oct. There was Oct '29 and then there was that Oct 87 thing. When Ben the dollar Slayer came into office as Fed chairman he said in his speech,"The Fed's goal will be to maintain the current expectations for inflation". This past April when oil was at the astounding price of $100/BBL "BTDS" testified for Congress, "We expect inflation to moderate in the coming quarters", "We expect oil prices to moderate due to weaker world markets in those same coming quarters". Ehhh..uhht real shrewd thinker...It will be a lot safer for you if you just buy the SDS or DXD even at these levels of valuation!!!

[wdzkjr]

Do not catch falling knives and wait for the dust to settle. I expect another round of Capital Raising before recovery. I too watch Fifth Third as well as National City (owned and sold in summer 2005 and into 2006) and will catch them on the way up only after economic conditions improve, but not now........probably late 2009-2010............b... keep one eye open

[helplessobserver]

Why waste your time with this stinker. BBT Bank is down 50% around $24 and just announced a dividend INCREASE to $0.47 per quarter. Their mortgage policy, 20% down or PMI. I expect their July 17th earnings will be very close to analysts estimats. For technicians, the stock capitualted recently with over 49M shares traded around 25.

[var]

ok, so I don't own any stocks in any banks, I have no clue what the first paragraphs means in this article. However, just a little common sense... thinking. 5/3 Bank would need to have some visible upside before I would invest. Right now its just a roll the dice and pray. I don't see anything that would make want to explore looking at ANY bank. Because of credit crunch they aren't making loans to start-ups and small business as much as before .

Plus there is a lot of competition from private lendors and peer-to-peer lending sources..... I'd put my money into the private sector not the stock market.

[ArtfulDodger]

Dear John: Thank you for your thoughtful and humble article. A definite change from what I usually read in the investing arena.

Here is something you should consider when thinking about buying into the banking sector.

Many banks aren't lending money and on top of that consumers aren't borrowing. So how will banks make any money over the coming years?

That should definitely be taken into consideration when discussing financials, along with this: How long will this last? The Fed is pumping money into the economy, but lending institutions fear the highly leveraged shape of the public. And rightly so. When, how, and what may change that?

No matter though, because in my view there is no hope in the long run to save our nation from its steady and definite decline, i.e, our nation as we've known it.

For as long as so many people want to keep leftists in power so that they can create more government to combat the problems and disasters that their government programs and legislation caused in the first place, we are eventually doomed economically.

And government bureaucrats do this over and over, but always wiggle out of what they've done by blaming private industry (Big Oil, Big Pharma, and the like, and of course a bogeyman such as Bush or Cheney or Rove), and the people for what they have brought about.

With the help of the Marxist media, the people then yell for the government to do even more, thus causing problems that will have to be faced in the future—and that means more government rules, regulation, and legislation that brainwashed parrots scream for.

And clearly, it doesn't help sending our forces around the world to carry out other nation's wars for them. You can't blame Bush for all of this either. The Dumborats in Congress voted to go get the Toy Tiger in Iraq (except for the members of the Black Caucus, which only votes for bills to punish American businesses and individuals); and Bush didn't put troops and bases in over 140 nations around the world. They were there when he took office.

Meanwhile, America has an invasion from the south, crashing stock markets and the dollar, along with hyper-inflation, declining property values, exploding crime (see Sean Hannity's America from Sunday, June 22, `08), and energy and food prices nearly equalling Germany's in the 1920s.

Enjoy the ride, especially those of you who're calling for even more leftists to take over so they can create more government to punish businesses and anyone else who is succeeding in the private sector.

Parasites engender more parasites of different types, because when one begins its feeding, it weakens the host, which invites even more suckers to the party. The host soon withers to nothing. Consider the American people the host.

[buylandinflorida]

I am considering taking my entire IRA,30,000 bucks, and buying FITB LEAPS. The Jan 2010 ATM's. I understand the risk, I just feel like this stock is worth 15 bucks before then, and I am hoping for at least a double. Your article was very helpful.

Thanks! Jason

[crudeoilcrackhead]

every day iI read a new article saying it is time to but into this bank or another. They all keep falling for the most part. They will continue to fall. Buyer beware, this is a problematic idustry and we still don't know the full extent of the problems.

[Foosie]

FITB is opening bank branches in Chicago right across the street from JPM and BAC (in different locations). It seems to me that this will keep its expenses out of line for a long time. It is not uncommon to see five banks in one block downtown, and a block apart in the neighborhoods. WAMU doing the same thing.

[PeakOiler]

"I am considering taking my entire IRA,30,000 bucks, and buying FITB LEAPS. The Jan 2010 ATM's. I understand the risk, I just feel like this stock is worth 15 bucks before then, and I am hoping for at least a double. Your article was very helpful."

My God, don't do this!!! The markets will finish their declines in December of 2008. DO NOT buy until then, and especially DO NOT BUY FINANCIALS. We are no where near the bottom, and as an assignment, suggest you review what happened in 1973-74, the biggest bear market since the Great Depression. This market is following that analog to a 'T'. That market decline ended on Dec. 26, 1974, and this one will likely come to an end in December 2008. Please don't even think about buying until then.

[Patpoc]

Too many young, not dry behind the ears, that have never had a real job, throwing dirt on many good companies. They need to realize a sound company is run of three month planning, but really by one, two, five, and ten year plans. Go out and get a real job.

[ellie_mae]

John, you hold the answer to Fifth Third's management problems, in your statement "The biggest negative is location. It is big in tough states, having three of its state concentrations in three of the worst five states for property foreclosure." Hum, which came first the Fifth Third's loan underwriting (lack of) standards or the foreclosure problem? I would go out on a limb and state that these states wouldn't have had as large of a foreclosure problem if Fifth Third didn't do business in these states.

[anothermongoose]

I suggest that you not buy FITB here at $10 per share. For one thing, read Barron's magazine, today's edition (6/30/2008). The chart really looks horrible. But other wide ranging considerations are really bothersome about FITB, and this is going to sound really negative, but so be it. FITB was NOT forthcoming in disclosing its losses. They were very much unlike KEY who was coming forth weekly with their problems. In fact, FITB lead their shareholders to believe that they were doing well, for example, when they expressed an interest to buy NCC back in April, when in fact they knew very well they were having huge problems of their own. Also, one has to wonder what assurances did FITB make to the regulators when they bought First Charter. FITB KNEW it was having huge problems in net charge offs and so how did they convince the regulators that the buyout should be a go ahead? Also, if you read the May 12th presentation by Kabat at the UBS Global Financial Services conference (on FITB's website) you'll see realtively little dire problems. Problems, yes, referred to as "emerging credit issues", when in fact FITB KNEW they were having massive hemoraging in various lending areas and geographic locations of the bank. Another issue is the dividend. In the first quarter of 2008 FITB paid a 44 cent per share dividend when was an INCREASE of a couple of cents from the 4th quarter of 2007. An increase in the face of absolutely huge and mounting losses. Highly misleadind, wouldn't you say? Finally, this garbage about the BOLI loss, bank owned life insurance, is stunningly STUPID. They have taken already some 300+ million dollar loss on the investments and i think that's about half of their exposure. They did not stick to their basic business when making these BOLI investments and the dimensions of the investments is outrageous.
My issues should cause you to consider whether FITB has been credible in its public pronouncements and actions and I for one believe they have been highly misleading. As is so often the case, the longer term shareholders get treated the worst of all -- declining value of the stock, reduced dividend, diluted future earnings.
I hope the two class action suits against FITB and Kevin Kabat, filed just in the past week or so, will be HIGHLY successful.
mongoose

[stoxing]

I will not stop you John. I believe that you are correct buying now.
good choice!

[User 220024]

I know that most banks stocks are lossing value, but none of these banks will face out but rather go up in value, it may take sometime, but they will, so the worst case scenario it may take sometime to go up in value of be bought out by another bank that their stock is higher in value, so they will go up in value as well, so lets give them a hand buy their stock this will help us all.

[JMF1968]

I must first confess to a certain amount of bias and myopia, as I am not only a 5/3 shareholder, but also a person who works in the mortgage division in Cincinnati. I have been with the bank since 2002. Normally, I wouldn't comment or post on a blog like this, as with my bias I am likely to be ridiculed or blasted out, but one comment in particular struck me as completely incorrect. Ellie-mae talks about our underwriting criteria. I can tell you, as a residential mortgage employee who has been with the bank for almost six years, and one who has originated, underwriten, coached and now works in compliance, our underwriting guidelines were always the strickest in our areas of operation when compared to other prime lenders. Most of the originators who work(ed) for us, complained that they were losing business to Countrywide, Wells and others, who had much less strick income, credit and asset requirements for their loans. Before casting aspersions such as 5/3 being responsible for the home loan crisis in the states we operate in, please do some research.

*I am not authorized to speak for the bank, and this posting is my own personal opinion and experience and in no way reflects that of 5/3 or any of its entities.

[catomine]

Do you all realize that when First Charter announced its sale to FifthThird, FT advised FC stock holders that stocks would be $43.oo if bought, and they advised a 70/30 split favoring stock. Those of us dumb enough to believe them found out that our stock was devalued and we ourselves lost $11,000.00 from their unethical practices. No one will answer questions, respond to letters, emails, phone calls, etc. except to say it was their perogative to reduce value even after advising the split. A den of thieves, a den of greed mongers, a den of liars. But what do you expect from bankers?

[John Hempton]

Thanks for the comments. Visit the blog. And if JMF1968 would contact me throught he blog I would be really grateful.

John

[DavidH]

I would not consider buying stock in 5/3rd bank at this time, because it lacks competitive banking products and services compared to other banks and lacks competent customer service. These 2 factors combined mean that, whenever 5/3rd must compete with other banks, 5/3rd will lose the business. Just as American carmakers must learn to make cars people want, 5/3rd must learn to offer banking products and services people want, at competitive rates and prices. That has not happened, the result being that long time 5/3rd customers like me are cutting back their business with 5/3rd in favor of other banks. We are moving our business checking accounts to PNC Bank as PNC has remote check deposit, 5/3rd does not. And why have savings with 5/3rd at less than 1% interest when other banks are paying 3% or more (e.g., ING Bank). And I could go on. In those rare situations where 5/3rd did have a competitive advantage over other banks that would attract new customers and investors, its management was too incompetent to understand and market those advantages, most of which have disappeared now that the bank is hungry for money. And look at the millions of ad dollars the bank has wasted on dumb TV commercials touting "The things we do for dreams." Because the management of this bank is incompetent and unfit I could not buy their stock. It would be similar to investing in the Titantic.