Fifth Third Bancorp has done enough workouts on troubled loans to know when it's time to give up.
The Cincinnati company, which has been squeezing better recovery values than expected from a wide array of bad credits, surprised analysts Thursday by announcing it had sold $228 million of residential mortgage loans and made $961 million of commercial loans available for sale late in the third quarter. In aggregate, the actions stand to reduce Fifth Third's real estate-related nonperforming loans by 40%.
"These loans represented situations where we believed a near-term sale was a better solution than a long-term workout or rehabilitation of the relationship," its chairman and chief executive, Kevin T. Kabat, said on a conference call to discuss quarterly results with analysts. "Their disposition further reduces our exposure to future real estate losses in what's anticipated to be a slow recovery."
The moves resulted in $510 million of new net chargeoffs and cost the company about $175 million of pretax income in the third quarter through a higher provision expense. Analysts said the hit was worth taking, especially considering that Fifth Third still managed to generate $175 million of net income available to common stockholders, topping second-quarter results by 35% and reversing a year-earlier loss.
Fifth Third "has both the capital adequacy and earnings power to absorb the unexpected provision, so we view it as a positive longer-term decision (even if it does confuse this quarter's numbers a bit) as opposed to a negative credit shock," analyst R. Scott Siefers of Sandler O'Neill & Partners LP wrote in a note to clients. The sweeping actions "improve forward credit optics and earnings power."
The third-quarter loan sales included $205 million of residential mortgages that were nonperforming and $23 million that were delinquent. More than 60% of the loans were concentrated in Florida. The sales cut the company's holdings of nonperforming residential mortgage loans by half. The loans retained would "generally be loans with a higher probability of loss mitigation, higher levels of collateral support or where market values were well below realizable value," said Mary Tuuk, chief credit officer for Fifth Third.
On the commercial side, Fifth Third intends to reduce nonperforming loans — primarily tied to real estate — by about a third. It has earmarked for sale about $180 million of loans related to residential real estate developers, $515 million for non-owner-occupied real estate, $138 million for owner-occupied real estate and $308 million for commercial and industrial loans. About a quarter of the loans are concentrated in Florida, with another 10% concentrated in Michigan.
"Really it comes down to, in the commercial portfolio, a loan-by-loan assessment of what our workout potential is [and the] likelihood of a successful outcome, and balancing that versus what our realizable value would look like today in [terms of] market pricing," Tuuk said. Most of the commercial loan sales are expected to be completed in the fourth quarter, she said.
Dynamics in the loan market have become much more favorable to banks in the past year, said David Tobin, a principal with Mission Capital Advisors LLC, which advises on loan sales. Between growing perceptions of a stabilization in real estate and the quest for higher yields in a low-rate environment, Tobin said loans are attracting more capital not just from hedge funds and private-equity firms but from strategic buyers, which might include a property owner adjacent to the borrower of a troubled real estate loan, or businesses interested in buying the debt of a weaker competitor.
By selling into a potential recovery, banks such as Fifth Third theoretically are leaving money on the table. But banks generally aren't equipped to hold onto bad real estate loans for the six to eight years it typically takes for valuations to return to precrash levels after reaching a crisis-induced bottom, Tobin said. And even if banks are willing to hold on, their investors probably aren't.
"It seems a little bit counterintuitive — if a bank is selling dud loans at a discount, you would think that might indicate problems. But in the environment we're in," Tobin said, "it's perceived as strength. It's the banks that can't sell that are perceived as being unhealthy."
PNC Financial Services Inc. in the third quarter followed through with a previously announced plan to sell $2 billion of residential mortgage and brokered home equity loans that the Pittsburgh company had described as "seriously delinquent." The sales, which lowered third-quarter average residential mortgage loans by 10%, brought down the size of PNC's distressed asset portfolio to $16 billion.
The portfolio "is down $4 billion since the same time last year, primarily as a result of pay downs, net chargeoffs and dispositions," PNC's chairman and chief executive, James E. Rohr, said Thursday on a conference call to discuss PNC's quarter. Net income attributable to common shareholders more than doubled from last year's third quarter to $1.1 billion, or $2.07 per share, and rose 39% from the second quarter.