Showing posts with label Fifth Third Bank. Show all posts
Showing posts with label Fifth Third Bank. Show all posts

Wednesday, July 23, 2008

CINFIN admits defeat on Fifth Third

In my first post on Fifth Third I noted that Cincinnati Financial (a well run insurance company) had a massive holding in 53 during its great run up. They retained the holding as the stock fell from $60 to $10.

Guess what - they sold half today - and the explanation makes no sense. They want to reduce their exposure to low-dividend stocks.

What is remarkable about the sale is that they are selling 480 million in stock after the price collapse - and they still have to pay 120 million in capital gains tax. That is reflective of how good a stock 53 was before it became bad...

And having to pay 120 million in capital gains tax is a high quality problem - but it would have been a higher quality problem to have paid 600 million in tax a few years ago!

Wednesday, July 9, 2008

Can someone explain why Fifth Third started taking brokered home equity loans?

Recently I chatted with Fifth Third management.

Fifth Third started taking brokered home equity loans late 2006. They took 2.7 billion of them. They also took loans out-of-footprint (that is where they had no branches). They took 900 million of them.

The loss-given-default (severity) of the home equity loans is rapidly approaching 100 percent on the whole portfolio but the default rate for the brokered loans is many times the branch originated loans even though the branch originated loans are in bad states.

The branch managers at Fifth Third have profit and loss accounts and are remunerated in part on them – so it figures that the branch managers were much more sensible than the brokers in rejecting patently bad or fraudulent credits.

But can anyone (please) explain the cultural change at Fifth Third that allowed them to take out-of-area loans through brokers?

Thanks.

John

Tuesday, July 1, 2008

Wachovia and negative amortisation

There is a press story here about how Wachovia is ceasing to orginate mortgages with negative amortisation features.

The headline:

SAN FRANCISCO (MarketWatch) -- Wachovia Corp. said on Monday that it won't offer mortgages with negative amortization features anymore, one of the main types of home loans offered by Golden West, the mortgage giant the bank acquired for $24 billion roughly two years ago.


This is a race: whose head is further in the sand, Wachovia or Barclays?

I wrote here how Fifth Third does not originate neg-am mortgages. Fifth Third (who have now contacted me) have not written such mortgages for years. The IR guy can't actually confirm that they ever wrote them.

Why are Fifth Third and Wachovia even mentioned in the same breath when it comes to difficult (multi) regional banks?

Search me.

Friday, June 27, 2008

Drink deeply of the poison: another look at Fifth Third Bank



Fifth Third 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 buying 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 an huge error of judgement 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. Its called believing your body odour 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 amortisation features and high loan to valuation ratios.

Fifth Third and Negative Amortisation 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 currrently" 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 all about them lost theirs.

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 - its good to return phone calls and emails.



John

Tuesday, June 24, 2008

The preposterously expensive WestAmerica Bancorp

In my post of Fifth Third I described WestAmerica as perhaps the most astounding unbroken story in American banking.

Here is its balance sheet from the last quarter – note that almost every category is shrinking:


The company is not shrinking because it is forced to by lack of capital. Contrary - almost alone amongst banks it is buying back lots and lots of stock. This is not a bank that is going to use its superior performance to build capital and buy its competitors in crisis.

The management is comfortable with shrinking. Even deposits are shrinking deposits (somewhat by choice). WABC would rather keep cheap deposits than compete for them on price and service. (Unfortunately their competitors are not so kind.)

Indeed the good stuff is all shrinking. Deposits are shrinking. No interest deposits (of which this bank is rich) are shrinking. Loans are shrinking. Equity is shrinking.

The bad stuff is also shrinking – particularly investment securities.

Everything is shrinking except the stock price.

The credit performance is great – amongst the best in North America. The local economy (driven by agriculture) is probably better than most. (They are in that great food bowl - the Central Valley of California.)

The bank is really hard to fault.

But it is preposterously expensive. Tangible shareholder equity (equity less goodwill) is 280 million. The market cap – 1.54 billion. Just under six times book. I have seen banks trade at that before – but not for a while. However those were banks priced for growth. This bank is negative growth. [The bank is over six times tangibles if you think deposit premiums are equivalent to goodwill.]

More to the point – the market cap is roughly half the (shrinking) deposits. Never seen that anywhere. Gosh we get excited at funds managers (who don't risk capital) when they trade at 10% of assets. We are at about 50% here. And fund managers with shrinking FUM tend to trade at very small percentages.

Further the earnings quality is not all its cracked up to be. The bank carries approximately 1.5 billion in investment securities – well over 5 times capital. About half these investment securites are pledged to provide floating rate financing – that is the bank is just running a big margin account to get some earnings. This is common in regional banks - and it works – but you would hardly want to pay a high teens multiple for those earnings. Most of the securities in this case are GSE debt, state and local debt, some mortgage backeds and some other "asset backed securities".

Still when banks are losing their shirt everywhere – this bank has come through remarkably unscathed.

Especially the stock price.

Monday, June 23, 2008

Things that stun me: Fifth Third Bancorp

I know a very successful fund manager who is utterly stunned by the problems at AIG. He thought that the company had “more there than that”. I had been watching what they do (rather than what they did) since 2000 and was not overly enamoured. I didn’t short it – but the problems were not a surprise.

My surprise came with Fifth Third Bancorp – a bank I once held out as – indeed still do hold out as – the best managed regional bank in the world. Given the wags are now calling it “Three-Fifths Bancorp” either I was wrong or something changed.

I contend that it was change. However the extent of the change – and the resulting problems amaze me.

The bank I hold out as the best managed regional bank in the world changed radically around the year 2000 in response to problems caused by its own success. These changes created a very different bank. I still maintain that Fifth Third circa 1990 was the best managed bank I have ever seen.

I shorted the stock once – above $60. A short made despite being totally enamoured of the management. I made pennies and was never truly committed. In my eyes we shorted the bank because its success was at an end – not because we thought it had major problems.

I noticed minor issues – but Moody’s rating agency did not. Moody’s mooted upgrading Fifth Third to AAA – a ranking that they have never come close to assigning to any other mid-size regional bank.

I didn’t drink the Kool-Aid completely. As the stock fell I was always looking for an opportunity to buy – remembering past glories. But thankfully I never pulled the trigger.

The old Fifth Third

I am doing this a little from memory because I (foolishly) tossed some of the old annual reports.

The bank arose from a pre-prohibition merger of a Fifth Bank and a Third bank of Ohio. I gather they were called Fifth Third because Three Fifths referred to a particularly strong liquor – and that was considered ungodly.

There was a major management change/restructure about 1975-76 (noted now only in the incorporation of the name Fifth Third Bancorp in 1975). However that was the beginning of one of the great stock runs in history.

After the 1975 restructure the bank operated the bank in a very entrepreneurial fashion. The bank was broken into small banks with about $3-5 billion in assets. The small banks purchased back office and other services from the mother-ship – and the mother-ship also sold back office services to third parties. Everything was expected to be market-best - and market signals were used to ensure it.

When a division got too big they broke it into two divisions. The division managers competed against each other and were paid as entrepreneurs. Part of the remuneration was paid in arrears and dependent on credit quality.

The culture had its minuses. For instance if you were from one part of Fifth Third and you wanted to use a photocopier people got a little stroppy. Why? Because your photocopy would go on their cost account. (I am not exaggerating – the businesses were sufficiently small and entrepreneurial they were worried about trivial costs.) But it was pretty hard to argue with success.

The outsource back-office businesses were not too bad either. The credit card processing facility – Midwest Payment Systems – was particularly good. It was to my eyes the best in the world – and was very profitable on the out-source service it sold. It has since been renamed Fifth Third Payment Solutions – I think as much to distinguish itself from MPS – the Bank of America payment business.

Fifth Third did small fill-in acquisitions in the four Midwestern states in which it had operations. Generally the small bank was entrepreneurial and stayed entrepreneurial after acquisition. Its cost structures however improved as it wound up with Fifth Third's exceptionally good back-office services.

The stock run was extraordinary. The stock was a 600 bagger from the restructure to 2000 (and more than 1000 bagger to peak). You don’t need to hold too many of those in your life. It even came through the 1992 debacle almost unscathed. [These stock runs include hypothetical reinvestment of dividends - the general point however still holds. This was the best performed bank in the world.]

Its utterly superior economics had nasty effects on other midwest banks. The other banks competed not by being better but by accepting worse credit. The poor credit culture at National City has its origins there. (For those not following National City is one of the banks worst hit in this crisis. The same observation with less stregth applies to Keycorp.)

I never held it – which is a great pity - however one company did hold a substantial stake in Fifth Third – that was the local (high quality) insurance company – Cincinnati Financial (Nasdaq:CINF). The combination of fairly good underwriting and a super-powered stock portfolio driven by Fifth Third (and to a lesser extent fellow Cincinnati company P&G) meant that CinFin was also a great stock. At various stages I have owned CinFin for pennies of profit.

Here is the balance sheet of Fifth Third from the 10K for 1999 – which was issued two years shy of the peak of the stock run. Whilst the run continued the problems set in after this balance sheet was issud.

The are a few things to note. Firstly that the bank was very small despite the massive stock run. The loans outstanding were under $25 billion. That would place it today as a small – even one state – regional bank.

The second thing to notice is how overcapitalised it was. The shareholder equity was over 4 billion on those loans. The bank could easily have run at half the capitalisation. The bank used its excess capital to speculate in securities – but as the yield curve in 2000 was fairly flat there was not much profit there.

On that balance sheet there is simply no way that Fifth Third was getting into trouble. Moody’s later mooted the AAA rating – but it could easily have been awarded then.

The post-tax profits for 1999 were 668 million. Not a large number – but a fine return on $2 billion of capital and $2 billion of excess capital.

Profits would have gone up sharply over the next few years without the bank doing anything much. The yield curve would steepen and the $12 billion in securities which were carried at very little spread became highly profitable. The bank unfortunately felt compelled to do things.

The bank’s problem

I am going to make the strange assertion that the bank’s biggest problem at this stage was its stock price. The price was in the high 30s at year end 2000 (along with most other banks that were at low prices as tech stocks dominated). But by late 2000 the stock price was just shy of $60. The market cap was over 18 billion and the PE ratio almost 30. [Note the 3 for 2 stock split in 2000 when checking my numbers.]

Four and a half times book might not have seemed unreasonable – but it was more accurately described as seven times book plus excess capital. This was a period when banks traded at less than a third this price. This was – by far – the most expensive bank in North America.

The high stock price meant high expectations which the management sought to meet. The excess capital couldn’t be solved by buying back stock (as the stock was so pricey). Instead they went to grow by acquisition.

The home markets – the four states which they had previously conquered – were saturated with Fifth Third. Fifth Third had used its superior economics to get the superior credits. Banks that had to compete with Fifth Third wound up on the worse end of pretty well every credit. Fifth Third had pristine credit.

If Fifth Third grew in the home states they would have to take some business that they had previously rejected. Growing in the home market would have turned Fifth Third into National City.

So they went to Florida as well as neighbouring Kentucky and West Virginia.

They used their inflated stock and excess capital to purchase things – but nothing they purchased was as good at the old bank. Moreover the rate of purchase was very high, the prices often puzzlingly high.

The real problem though was that the management system that had served Fifth Third so well through the glory years became unwieldy. The bank when I started following it had 8-10 businesses all competing against each other. I stopped following when this got to 71 businesses. The internal bickering about cost allocation became thunderous.

My short – when I had one on – was not predicated on the failure of Fifth Third – but the slow demise of the business model.

Well we got the near failure of a natural AAA bank. The story is well told by Mish and others – and I am not going to repeat it here.

Lots of its businesses have blown up. The credit card processing business is not as good as it was. Midwestern credit is awful. The stuff they purchased in Florida is worse. But worst of all was that they grew hard into it.

Whereas Fifth Third was almost perfect during the 1992 banking debacle its been a total mess this time.

Count me as surprised.

There are a couple of other pristine stories in North American banking - notably WestAmerica Bancorp, and Mortgage and Trust Bank (MTB). The former is remarkably expensive (and successful) for a well run but otherwise undifferentiated regional bank in the Central Valley of California. The latter has non other than Warren Buffett vouching for the management. Berkshire is the largest shareholder.

I look at these companies and I can't fault these banks. But that wouldn't have saved a Fifth Third shareholder.

But if WABC were to blow up - then I would be feeling deja vu all over again.

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The content contained in this blog represents the opinions of Mr. Hempton. You should assume Mr. Hempton and his affiliates have positions in the securities discussed in this blog, and such beneficial ownership can create a conflict of interest regarding the objectivity of this blog. Statements in the blog are not guarantees of future performance and are subject to certain risks, uncertainties and other factors. Certain information in this blog concerning economic trends and performance is based on or derived from information provided by third-party sources. Mr. Hempton does not guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. Such information may change after it is posted and Mr. Hempton is not obligated to, and may not, update it. The commentary in this blog in no way constitutes a solicitation of business, an offer of a security or a solicitation to purchase a security, or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.