Fifth Third Preferred: Consider Other Options

Summary

• Fifth Third's Series K preferred shares dropped precipitously in March.
• The rebound in the interim has returned the shares to within striking distance of redemption value.
• The rebound makes the preferred shares relatively unattractive from both a return and yield standpoint compared to alternative options.
• Preferred shareholders should consider reallocating funds.

Fifth Third Bancorp (NASDAQ:FITB) is a large regional bank serving a broad swath of the United States roughly extending from Illinois southeast through most states into Florida. The company’s common shares have been impacted, much like all banks, by concerns about coronavirus related closures and the financial impact this will have on loan portfolio losses. Indeed, Fifth Third booked provisions for loan losses above net charge-offs of $399 million in the most recent quarter, a trend which will likely continue to one degree or another for the foreseeable future.

However, our focus here is on the company’s preferred securities and particularly the company’s Fifth Third Bancorp 4.95% Noncumulative Perpetual Preferred Stock Series K (NASDAQ:FITBO), although our view is generally applicable to any of the three series Fifth Third's exchange-traded preferred shares. The series was added to our portfolios (along with several similar issues) in March when prices of exchange-traded notes and preferred shares briefly crashed across the board. However, in the interim, prices have rebounded significantly from the lows, reducing the relative attraction of the preferred securities.

Series K Preferred Shares

The Fifth Third Bancorp 4.95% Noncumulative Perpetual Preferred Stock Series K is an exchange-traded series of preferred stock with a fixed dividend yield of 4.95% of the stated redemption value of $25.00 per preferred share (or $1.2375 per annum). The preferred shares are redeemable by the company at the redemption price at any time on or after September 30, 2024. The preferred shares, as with all of the company’s preferred stock, is perpetual such that the company is not required to redeem the preferred shares at any time. In the case of individual investors, the preferred dividends are also qualified dividends, providing an additional tax incentive.

Our position in the Series K preferred share originated when the market valuation of the preferred shares – and fixed income securities across the board – collapsed towards the middle of March. In comparison with the company’s other outstanding series of preferred shares, the Series K fell much further below redemption value and at one point reached a mere $10.50 per preferred share, less than half the redemption price, resulting in an effective yield approaching 12%. The variation in lows among the company's preferred shares generated a result where the Series K, despite its lower stated yield, in our view provided a more compelling overall return profile at a price which reflected nothing short of financial calamity. The subsequent rebound has provided a significant short-term return for holders and has sent the effective yield declining to 5.1%. This is not to say that additional gains are not possible. The preferred shares continue to trade at a discount to their redemption value, unlike the company's other preferred shares, but the potential gains going forward are not sufficiently attractive to justify holding a material position in the preferred shares. Indeed, even if the preferred shares rose back towards $26.00, returning to their pre-coronavirus peak above the redemption price, the additional capital gain is a modest 7.9%. In addition, while the effective yield would decline to 4.8%, the yield to redemption would be still lower. In this context, it's difficult to justify maintaining a significant position, especially since the potential return on many bank common shares, assuming one is willing to accept the interim volatility, is far higher despite only slightly lower dividend yields.

Fifth Third’s Other Preferred Issues

Fifth Third also has three other series of preferred shares outstanding, although only two trade on exchanges, as follows:

Fifth Third 6.0% Noncumulative Perpetual Preferred Class B Series A (FITBP) is an exchange-traded series of preferred stock which was issued to holders of a similar series of preferred stock of MB Financial as part of Fifth Third’s acquisition of the company. The preferred yields 6.0% on the redemption value of $25.00 per preferred share (an annual dividend of $1.50) and is redeemable by the company on or after November 25, 2022. The Seeking Alpha platform does not currently recognize this series of preferred stock, although there is a legacy listing for the MB Financial preferred shares.

Fifth Third 6.625% Fixed/Floating Noncumulative Perpetual Preferred Series I (FITBI) is an exchange-traded series of preferred stock which yields a fixed dividend rate of 6.625% on the redemption price of $25.00 ($1.65625 per annum) until December 31, 2023, at which time the dividend rate converts to a floating rate of three-month LIBOR plus 3.71%. The company may redeem the preferred shares at the redemption price at any time on or after December 31, 2023.

Fifth Third 5.1% Fixed/Floating Noncumulative Perpetual Preferred Series H is not listed by the company on an exchange. The Series H preferred stock provides an initial dividend yield of 5.1% ($51.00 per annum) on the $1,000 redemption price which converts to a floating yield of three-month LIBOR plus 3.033% on June 30, 2023. The company may redeem the preferred shares at the redemption price at any time on or after June 30, 2023.

The other two series of exchange-traded preferred shares trade at premiums to redemption value, reflecting the relatively higher yield, although as a result having generally similar yields to earliest redemption.

Conclusion

The sharp rebound from the lows posted in March significantly reduces the attraction of the preferred shares. Income oriented investors may remain interested in the shares as a stable income source, although we believe more attractive exchange-traded bank notes and preferred shares are available, often still at a discount to redemption value. New York Community Bancorp’s preferred shares (NYCB.PA) are one example for those willing to tolerate the specific exposure to New York City real estate. Alternately, First Internet Bancorp (INBK) has two series of exchange-traded subordinated notes with fixed-to-floating yields and relatively short maturities (INBKL and INBKZ) which also trade at a discount to redemption and provide higher (though not tax advantaged) yields. In addition, the rather modest fixed dividend rate of 4.95% for the Fifth Third Series K preferred shares, on the lower end of bank preferred shares generally, limits any potential appreciation over the redemption price despite the present low interest rate environment.

Given the modest preferred dividend rate and quick rebound close to the redemption price, we believe better long-term opportunities exist both among notes and preferred issued by other financial institutions and, indeed, even in common shares of Fifth Third itself and other regional and community banks, many with only modestly lower dividend yields. Investors would be wise to consider alternative options and capture gains, especially for those who acquired shares during the brief panic only some 45 days ago.

Analyst’s Disclosure: I am/we are long FITBO, FITB, NYCB.PA, INBKL, INBKZ. 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.

In addition, we are short put options for FITB.