As the Dust Settles, Which Ohio Bank Fared Better?
Shareholders of the big three Buckeye State banks have endured some hard times.
After years of sturdy returns and attractive dividend payments, shareholders of Fifth Third Bancorp (FITB), KeyCorp (KEY), and Huntington Bancshares (HBAN) saw the value of their holdings fall precipitously as the U.S. economy plunged into the greatest recession since the Great Depression. Not only did shares shed about 90% of their market value, but the banks' tangible book value also got walloped from monumental loan losses and dilutive new equity offerings. While we think the worst is over, none of these banks is completely out of the woods yet.
In 2007, as the economy worsened and credit issues started to emerge, these banks' shares started what looked like a free-fall. To be sure, all three banks had to take credit baths, with net charge-offs reaching between 1%-2% of loans in a single quarter--higher than their traditional loss rates for a full year. It was a vicious cycle. Mounting loan losses and grim economic news dealt heavy blows to both current and expected earnings, which in turn took big bites out of the firms' capital and increased the likelihood of dilutive equity issuances at distressed prices--only to propel share prices lower. At this cycle's worst, in early 2009, both Fifth Third's and Huntington's shares lost nearly 95% of their 2006 prices, and around 85% of KeyCorp's value vanished. As a result, the price/tangible book ratios for Fifth Third and Huntington bottomed out at just 0.3 times, which was clearly the result of a panicked sellout that factored in a relatively high--and, likely, unwarranted--probability of failure, in our opinion.
Substantial credit losses and numerous capital issuances hammered the banks' tangible book value per share. Huntington, mired in nonperforming loans from its ill-fated Sky Financial acquisition in 2007, saw its tangible value fall by 60% as loan losses took their toll and the company was forced to raise more and more equity. In contrast, Fifth Third took advantage of its profitable payment-processing business by selling half of it in order to reduce the capital requirement of the government's Supervisory Capital Assessment Program. Thus, Fifth Third's equity needs were not too onerous and its tangible book value fell by a relatively mild 35%.
Even though none broke the regulatory capital ratio minimum, each bank's equity became quite meager in late 2008. For example, at its lowest, Huntington's tangible common equity ratio (tangible common equity/tangible assets) was a mere 3.8%, which is quite low, especially if the firm holds a mountain of sour loans and its loan loss allowances are thinning. We think that a slim capital base, together with elevated noncurrent loans (nonaccrual loans plus loans 90 or more days past due) and inadequate coverage (loan loss reserves/noncurrent loans) are a clear indication of problems to come since it's likely that the company's earnings will keep feeling the pressure from lofty provisions for loan losses as the bank replenishes its battered reserves. In addition to dilutive equity raises, all three firms slashed their dividend payouts down to a measly penny in an effort to preserve as much capital as possible.
Slowly, the largest banks in the Buckeye State have dealt with their various credit troubles and we think all three have turned a corner with respect to profitability. While still nothing to get too excited about, we think all three institutions will post positive income figures in the coming quarters. Although noncurrent assets (noncurrent loans plus foreclosed real estate) still make up a meaningful portion of their balance sheets, coverage is much better than in the past, especially for KeyCorp. Using the latest FDIC data, both KeyCorp and Huntington have lower nonperforming asset ratios than the system average of 3.1%, and all three have better coverage than the average of 0.6 times. As a result, we expect these three lenders' provisions will trend down and remain below their actual charge-offs as they release some of their previously amassed reserves.
In addition to leaving the worst credit losses in the past, we think all three banks have left their most worrisome capital issues behind. KeyCorp recently repaid $2.5 billion in TARP funds to the Department of the Treasury, making it the last of the three banks to relieve itself from the burden of its preferred dividend. Both Fifth Third and KeyCorp repaid TARP in early 2011, and by our calculations both of their pro forma fourth-quarter 2010 tangible common equity ratios would be around 9.0%, which we think is quite a hefty level. Although Huntington's ratio is lower at around 7.5%, we still think its positive earnings will help the firm maintain a healthy capital position without having to tap the capital markets again.
In sum, we think that the three biggest banks in Ohio can be cautiously optimistic about their futures. Absent another significant fall in the economy, we think these institutions should be able to slowly make their way back to double-digit returns on equity and conservatively raise their dividends. At current prices, we think that KeyCorp and Fifth Third have more upside potential than Huntington, but we would rather wait for a more favorable entry point with a wider margin of safety.
Maclovio Pina does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.