Fifth Third Sees Worse Year in '09

The Company

Fifth Third (FITB)

Share price as of Tuesday's close: $12.73

Share price now: $9.26

Percent change: -27.3%

Volume: 103.7 million shares, daily average 9.5 million

The News

According to a Securities and Exchange Commission filing, the capital increase, required following unexpectedly high loan losses, will be accomplished by selling $1 billion of convertible preferred stock. The filing did not specify the conversion price for the shares. Fifth Third plans to raise as much as another $1 billion by selling off noncore businesses. The bank cut its quarterly dividend to 15 cents a share from 44 cents a share.

Fifth Third said it was taking these actions "to strengthen its capital position in light of continued deterioration in credit trends during the second quarter of 2008 and its view that conditions are unlikely to improve in the near-term."

Fifth Third shares have shed 70% over the past year as investors fled the financial sector. "We expect these actions to enable us to weather further depreciation in home prices as well as a significant weakening in economic activity relative to current levels," said Kevin Kabat, president and CEO.

On Tuesday, Kabat was named chairman of the bank's board, replacing George Schaefer, who retired as CEO in April 2007. The bank said it was following an established succession plan.

Fifth Third is scheduled to report second-quarter earnings on July 22.

The Analysis

In aggregate, U.S. banks have already drummed up about $120 billion in new capital since the subprime crisis broke, and may need to raise another $65 billion to cover further loan losses, according to Goldman Sachs analyst Richard Ramsden.

Fifth Third earned 26 cents a share for the first quarter, well short of Street estimates of 49 cents a share. It had to set aside $544 million to cover bad loans during the quarter, more than five times the $84 million reserve it had in the year-ago quarter.

By this time next year, though, a $544 million haircut should seem not so bad. "Additionally, we currently expect 2009 net charge-offs to be higher than 2008 levels and provision expense to continue to exceed charge-offs, resulting in continued growth in our loan loss reserves," the bank said in Tuesday's update.

Fifth Third now expects its charge-off ratio, the percentage of loss reserves relative to its loan portfolio, to range between 1.6% and 1.65% for 2008. It expects the annualized rate to reach 1.7% in the second half of the year, up from a range of 1.0% to 1.15% given in earlier guidance.

Peter Winter, an analyst at BMO Capital Markets, downgraded the stock to Market Perform from Market Outperform Friday. He worries that the bank's worst-case scenario could yet get worse.

"The only surprise was the given magnitude of the increase in net charge-offs relative to their original guidance, and the fact that 2009 is going to be higher than 2008," he says. "You start to wonder that part of this increase is the concern that credit issues are spreading into other loan portfolios, beyond real estate, home equity, the homebuilders and land development."

The Bottom Line

Dan Wantrobski, an analyst at Fox-Pitt Kelton Cochran Caronia Waller, wrote Wednesday that Fifth Third's news was troubling, and "confirms that we're far from out of the woods," amounting to "the first confirmation by a bank (in my view) that '09 will be worse."

Winter says the fallout from the credit crunch is far from finished. "The reason it's not the trough is unfortunately, no one knows how bad this credit cycle could get," he says. "There's nothing to indicate that we're near a bottom."

Fifth Third wasn't first to the confessional, but chances are it wasn't last in line.

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