In its latest deal, Fifth Third Bancorp said Thursday that it agreed to acquire First Charter Corp., a Charlotte company with significant exposure to the Southeast's commercial real estate sector, for $1.1 billion, a price some analysts described as expensive.
The price is a 53% premium over First Charter's closing stock price Wednesday.
"Real estate is a hot button issue," said R. Scott Siefers, a Sandler O'Neill & Partners LP analyst. "No question, when someone is in the Southeast, it's a concern."
However, both he and Kevin Kabat, chief executive of Cincinnati-based Fifth Third, said First Charter is faring better than other banking companies in the region when it comes to credit quality.
"There are a lot of concerns in this environment," Mr. Kabat said. "It's something we have to be sensitive to." However, Fifth Third spent nine months talking to First Charter, and extensive due diligence has made him "cautiously optimistic" about the deal.
"They are a fairly conservative lender. By and large, their portfolio, and their performance, has been outstanding," he said in an interview.
As of June 30 commercial real estate loans made up 30.8% of First Charter's loan book, versus 28.8% a year earlier. Such loans grew 23.5% in the second quarter from a year earlier, to $1.1 billion.
During second-quarter earnings season, the $4.9 billion-asset company was one of several in the region to cite a rise in loan-loss provisions as a result of exposure to a fraudulent real estate developer. It reported a $7.8 million provision tied to 70 loans with an aggregate outstanding balance of $14.1 million and said the loans were based on inflated appraisals on properties in the North Carolina village of Penland.
Some analysts have expressed concern about coastal markets in the Southeast. First Charter's chief executive said such concerns were less applicable to his company than to others in the region.
"We have very small exposure to the coastal market in South Carolina. We are not concerned about that," Robert E. James Jr., First Charter's CEO, said Thursday. "We've been very selective" in underwriting, "and the economy has been very strong in North and South Carolina," Mr. James said.
The commercial real estate hiccup was not the only issue First Charter wrestled with in recent quarters. It had to postpone its annual earnings filing with the Securities and Exchange Commission this year. When it did file in April, it disclosed that "internal control over financial reporting was not effective" at yearend, because of issues related to last year's acquisition of GBC Bancorp Inc. in Atlanta. Charles A. Caswell, who said in May that he would resign as First Charter's chief financial officer because of the issue, is leaving today.
In the first half First Charter's earnings fell 6.1% from a year earlier, to $21.3 million, but revenue rose 16.3%, to $113.9 million. In the second quarter its loans grew 15.7%, to $36 billion, and deposits rose 8.1%, to $3.2 billion.
"They're getting a bit of a fixer-upper," said Kevin Fitzsimmons, a Sandler O'Neill analyst.
However, Mr. Kabat said, "Since we have been … courting this company for a while, we are very familiar with all of those issues, and we feel very comfortable that they really put that behind [them]."
The problems were not the reason First Charter wanted to sell, Mr. James said; being a part of a larger company, with more capital and products while retaining local decision-making, would enhance its ability to expand. Mr. James would become president of Fifth Third's 19th banking unit, Fifth Third Bank North Carolina, after the deal closes in the first quarter.
The deal is Fifth Third's second in the Southeast in four months, following its $288 million agreement in May to acquire the $3 billion-asset R-G Crown, a Casselberry, Fla., division of R&G Financial Corp. of San Juan, Puerto Rico. That deal marked the $101 billion-asset Fifth Third's re-entry into the acquisition market after a two-year absence.
By acquiring First Charter, Fifth Third would get 59 branches, mostly in Charlotte and Raleigh, including a two-branch foothold in the Atlanta market. It would enter Georgia with the purchase of R-G Crown, which has three branches in Augusta. Mr. Kabat said Fifth Third would look for more deals in Georgia but also would build branches there.
Though Fifth Third will continue to look at the Southeast, it also is interested in participating in the consolidation of the fragmented Midwestern market. Mr. Kabat said it is also eyeing the Middle Atlantic states. Fifth Third has the capacity to make larger deals, Mr. Kabat said. "We would be comfortable in the $1 billion to $5 billion market cap size. … That's our core strike zone."
That assertion might not sit well with analysts.
"They are losing financial flexibility," and Fifth Third's next cash deal would require it to raise debt, cut back on stock buybacks, or lower capital levels, said Peter J. Winter, an analyst with Bank of Montreal's BMO Capital Markets Corp. Reducing capital might not be a good idea at the beginning of a credit downturn, he said. Also, the price of the First Charter deal, and the fact that it is the second deal in short succession that would require cash, would limit Fifth Third's ability to expand further, he said.
Fifth Third valued First Charter's shares at $31, a 26% premium over their price on Dec. 31, before the stock, and most others in the banking sector, began a steep decline.
Citing the market premium, Gary B. Townsend of Friedman, Billings, Ramsey & Co. Inc., downgraded Fifth Third's shares to "underperform," from "market perform." He said the purchase would be dilutive to earnings for two years.
Mr. Kabat said the 32% premium on core deposits "is actually a little bit lower than what was paid for Southeast deposits in the past," and that the overall price is attractive "on some of the other metrics, like price to the last 12 months of earnings" or book value.
"We think it shows good financial discipline," he said.
Fifth Third's shares fell 2.7% Thursday, while First Charter's rose 38%.