Fifth Third Bancorp. is running out of options.
The $120 billion-asset company's sale of a majority stake in its payments processing unit is expected to raise $1.2 billion of Tier 1 capital, and the Cincinnati-based Fifth Third in recent months has sold $3.4 billion in preferred stock to the Treasury Department and sliced its dividend to a penny.
But with loan losses showing little sign of abating and the government's stress test looming, the company will probably need to raise more capital and could follow the lead of Citigroup Inc. and convert preferred shares to common stock.
"They would need to convince investors to convert, and it remains to be seen if that would be enough," said David George, an analyst at Robert W. Baird & Co. Inc.
In a client note Monday Robert Patten of Regions Financial Corp.'s Morgan Keegan & Co. Inc. agreed that Fifth Third is likely to need more capital. Though selling the processing unit "buys time," he noted, the "transaction is also a negative in that the processing unit represents the bank's fastest-growing revenue stream."
In 2008 revenue from the payment processing business rose 11%, to $913 million, a bright spot in a year when Fifth Third lost $2.2 billion. Its total revenue last year was $6.48 billion, compared with $5.5 billion the previous year. The bank does not break out profit for the payment processing business.
Though the recession that started in December 2007 has deepened Fifth Third's problems, its decline predates the current financial crisis. The company in recent years looked to expand beyond the slow-growth Midwest in a push that led it to acquire in Florida, where it is now struggling with falling real estate values and surging defaults.
Fifth Third has posted three straight quarters in the red, including a $2.18 billion loss in the fourth quarter when it was weighed down by a $965 million goodwill impairment charge and an $800 million writedown tied to a portfolio of commercial real estate loans in Michigan and Florida. The company also moved $1.8 billion in CRE loans to held-for-sale status in the quarter and has said it is willing to shed them for one-third of their face value.
In its latest effort to shore up its financial position, Fifth Third said Monday that it would sell a 51% stake in the processing unit to Advent International in a deal that values the joint venture at $2.35 billion. Terms call for the Boston buyout firm to make a cash payment of $561 million to Fifth Third. The bank will lend $1.25 billion to the new company to help fund the deal and will retain a 49% stake.
Many thought Fifth Third would sell the processing business outright as it considered sales of noncore assets. The company's other assets include an asset management unit and branches in Florida, but those might be difficult to sell at a good price, George said.
In an interview Monday, Kevin Kabat, the chairman and chief executive of Fifth Third, would not comment on whether the company is adequately capitalized, noting that it will soon report first-quarter earnings. But he did say that the deal with Advent will strengthen the company in the near term.
"This structure is the most beneficial one for our shareholders … and it is the most efficient and effective way of raising additional capital," he said. The sale will help Fifth Third expand revenue as Advent seeks to build the business globally, he added.
"We wanted to find someone who could help with the technology and provide us with an international platform, which we have not successfully broached in the past," Kabat said. "This will benefit us longer term. It will take some time to grow the business, but in a challenging environment we will be investing in it."
Kabat also said the transaction ends an initiative begun last summer to review noncore assets. Fifth Third is unlikely to sell other assets anytime soon, he said.
Though Fifth Third shares leapt on the deal news, analysts said investors should be wary of the company until its capital position is clearer. Even with $1.2 billion in new capital from the deal, Fifth Third's tangible capital equity ratio would have been 5.2% at Dec. 31, compared to the actual 4.2%, still lagging many of its regional competitors.
The transaction would boost Fifth Third's Tier 1 capital ratio by about 90 basis points, to 11.5%.
Loan losses continue to climb at Fifth Third; its fourth-quarter provision rose 153% from the third quarter and 729% from a year earlier, to $2.36 billion. Nonperforming assets rose 7.1% from the third quarter and tripled from a year earlier, to $3 billion.
Chris Pike, a managing director at Advent, said the firm plans to extend the reach of Fifth Third's processing unit into Europe through acquisitions. The buyout shop has been an active buyer in financial services in recent years, acquiring five processing businesses, including a $260 million deal in October for Experian France's credit card processing business.
Pike said Advent approached Fifth Third about the deal last year. Because the banking company was reluctant to sell the profitable unit outright, they opted to structure the transaction as a joint venture. At $2.35 billion, the venture's valuation is 41% lower than an estimate Fifth Third gave in November 2007.
The deal values the processing company at about 8.2 times its 2008 earnings before interest, taxes, depreciation and amortization. That is relatively cheap, given that processing businesses fetched 13 times to 14 times EBITDA earnings at the peak of the buyout boom in 2007.
Pike said that Fifth Third's kicking in financing for the deal was crucial because the leveraged loan markets have virtually shut down.
Buyout activity has fallen about 85% in 2009, with about $7.9 billion in deals announced to date, compared with $53.4 billion the year earlier, according to Dealogic.
"There is a lot of money sitting on the sidelines," said Robert F. Kennedy, a partner in the private-equity practice of the Jones Day law firm.