Fifth Third Bancorp's (NASDAQ:FITB) situation was a bit hard to read when it first released some contradictory metrics in its first-quarter financials. The bad news was the bank's profits dropped 96% in the quarter. Add in some potentially problematic litigation, and it has been trading below its peers for much of the time since the coronavirus pandemic struck the economy.
But the bank also set aside a lot of cash to cover future expected loan losses -- more so than its competitors -- and still managed to turn a profit. Its portfolio does not look to be crazily impacted by the pandemic, and its low price to tangible book value (P/TBV) could make it a good acquisition candidate when mergers and acquisitions (M&A) activity resumes if the bank stays at those levels. Fifth Third still looks like a buy.
Conservative credit provisioning
Ohio-based Fifth Third is one of the largest asset managers in the Midwest, with $374 billion in assets under management. It has $185 billion in assets, and a presence in Kentucky, Indiana, Michigan, Illinois, Florida, Tennessee, West Virginia, Georgia, and North Carolina.
After the coronavirus pandemic sent the economy into a tailspin in the first quarter, credit quality became vastly more important to banks. Given that the sudden shock to the economy has cost millions of Americans their jobs, many borrowers are now at significantly higher risk of defaulting on their loans. And bad loans are one of the primary drivers behind bank struggles ... and failures.
So, going into the quarter, there was an intense focus on credit quality, specifically on how bank management teams were projecting their future loan losses and how much cash they were setting aside to cover them. After setting aside $625 million in loss provisions in Q1, and increasing its total reserves to account for the new current expected credit loss (CECL) accounting method, Fifth Third had $2.5 billion in total reserves to cover future expected loan losses. That is equivalent to 2.13% of the bank's total outstanding loans, which after just a few weeks of the coronavirus at the end of Q1, was a very conservative allowance compared to most of Fifth Third's peer banks.
On one hand, it's great to see a bank thinking cautiously, especially in times like these. But on the other hand, some analysts on Fifth Third's most recent earnings call questioned whether management's choices reflected genuine conservativeness, or whether they might instead indicate something materially wrong in its loan book.
Nothing from the numbers appears too out of place, though. Roughly 11.7% of the bank's portfolio of loans is in industries highly impacted by the pandemic, such as restaurants, retail, and healthcare facilities. Oil and gas loans make up less than 3% of the bank's total portfolio.
While nearly 64% of Fifth Third's loan book is in commercial loans, Chief Risk Officer James Leonard said on the earnings call that "the focus for us has been on companies with larger scale that should be able to persevere in this environment." One metric that shows this, according to Leonard, is the fact that 75% of the bank's commercial and industrial loans in industries most negatively impacted by coronavirus are shared national credits -- loans of more than $100 million shared among at least three lenders. "Our loan book, I would tell you, is comprised of high-quality, liquid, resilient names," added Leonard.
The consumer loan book seems strong as well. Roughly 56% of borrowers have FICO scores of 720 or more, and only 26% have scores below 660. Another thing to note is that loans only make up about 64% of the bank's total assets. Fifth Third also has a $38.6 billion securities portfolio composed largely of safer and more liquid residential and commercial mortgage-backed securities.
The other aspect that makes Fifth Third stock a buy now is the fact that it has been mentioned as a possible acquisition candidate. Morningstar analyst Eric Compton said a few weeks ago that he saw Fifth Third as the most likely candidate out of banks he covers to be bought out by PNC Financial Services Group, which is likely in the market to buy a bank. When banks get acquired, the deals typically happen at a nice premium to their previous stock prices.
Fifth Third recently had a P/TBV in the bottom half of large regional banks with between $40 billion and $500 billion in assets, although the bank's P/TBV has come up as the market has rallied as of late (at Friday's close, Fifth Third was trading at a slight premium to PBV). This suggests that the market is more concerned about Fifth Third than it is about other regional banks. While the bank did have strong performance metrics before the virus, the market could be focused on the huge decline in profits in the first quarter.
Investors could also be thinking of the recent legal issues. In early March, the Consumer Financial Protection Bureau sued Fifth Third, saying the bank opened unauthorized deposit and credit card accounts in customers' names and enrolled customers in products they didn't actually choose. The allegations are reminiscent of Wells Fargo's phony accounts scandal, which resulted in a $3 billion fine and an extremely restrictive asset cap. But the CFPB is not claiming that Fifth Third violated the law, and we don't yet know the scale of the fraudulent activity. In Fifth Third's statement on the suit, it identified fewer than 1,100 unauthorized accounts out of some 10 million overall opened from 2010 to 2016.
A low P/TBV is a quality that can make a bank a more attractive acquisition candidate, at least when M&A activity revives. Right now, it seems like Fifth Third would make for a good purchase if it were willing to sell itself. In addition to its strong performance metrics before the virus, in recent quarters, its non-interest income has made up between 45% and 50% of its total revenue. That would be attractive to any potential buyer right now because, with benchmark interest rates near zero, it's going to be difficult to make meaningful yield off of loans.
More than one way to win
The big Q1 losses and legal issues surrounding Fifth Third present some variables and mysteries down the road for the bank. But based on what seems like a somewhat stable loan book and conservative loss provisioning, I think there are ultimately a few different likely scenarios that make this stock a buy. On one hand, the bank's management team likely provisioned prudently; the lawsuit could turn out to be less of a problem than initially thought, or already priced into the bank's stock price; and the bank can return to its strong performance metrics. On the other hand, the shadow of the lawsuit and concern over profit losses and a higher reserve level continue to make the bank trade lower relative to its peers, making an acquisition -- and likely a nice premium on the stock -- more of a potential outcome. I think there are multiple routes this company can go and still return good value to shareholders down the road.