Leaders Leave Fifth Third

December 9, 2005
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GRAND RAPIDS — A number of senior management leaders have left Fifth Third Bancorp, and though analysts agree some changes at the executive level are to be expected, some see the Fifth Third’s executive fallout as excessive.

In fact, some analysts see it as a “significant fundamental negative.”

Neal E. Arnold, 45, executive vice president and second in command at Fifth Third Bancorp, resigned Nov. 28, just two months after 40-year-old CFO Mark Graf’s sudden exit from the company “to pursue other career opportunities.” Arnold had been identified as the clear successor to CEO George Schaefer.

The buzz about a possible acquisition of Fifth Third by either San Francisco-based Wells Fargo or Minneapolis-based U.S. Bancorp began circulating in October, but it’s still speculation at this point. When Jonathan Smith, executive vice president for commercial lending, suddenly left the bank’s West Michigan headquarters just two days after Arnold left, it begged the question: Is Fifth Third reorganizing?

Michelle Van Dyke, president and CEO of Fifth Third Bank West Michigan, referred questions from the Business Journal to Peggy Janei of corporate marketing and communications at Grand Rapids headquarters. Janei said the company is not reorganizing.

“People leave from business all the time; they have to make a decision whether they’re going to stay with a company or not,” Janei said. “Neal Arnold is one person in a sea of a whole bunch of EVPs (executive vice presidents) down in Cincinnati. One person leaving doesn’t make a reorganization.”

Equity Research Analyst Fred A. Cummings, managing director of KeyBanc Capital Markets, said some of the departuresfrom Fifth Third have involved executives who had been with the company 25 to 30 years. “Those executives were very wealthy; they walked away with millions of dollars of stock,” Cummings said. “In many cases it was reasonable for these executives to retire. However, when you look at the last two departures, the most recent being Neal Arnold, clearly there was a controversy surrounding him.”

Cummings said there could have been some performance-related issues with Graf and the company asked him to leave, but Arnold’s resignation was a surprise move. “In big corporations things happen, but I don’t think it’s necessarily a sign that they are going through a reorganization,” he said. “But, clearly, they’ve had some operating issues and that might explain why Neal Arnold and Mark Graf are no longer with the company.”

Research Analyst Denis LaPlante of Keefe, Bruyette & Woods Inc. said any time there is executive turnover in a company it raises questions. “The turnover in management that we’ve seen is above normal. I think the turnover has been a little excessive relative to most bank holding companies over the last few years, but a fair amount of them were planned retirements and some of them were performance related,” LaPlante said. “There have been a lot of changes at the bank affiliate level and a lot of those changes at the bank affiliate level have been positive changes.”

His company has “market perform” or “hold” classification on Fifth Third Shares. LaPlante thinks the takeover speculation is “a little misguided.” He doesn’t think the company is for sale, but said the probability is “never zero.”

Fifth Third has had some earnings challenges in the past three years and some regulatory challenges, as well. In March 2003 federal regulators required Fifth Third to strengthen its internal controls and risk management process. The Fed lifted the agreement in April 2004.

Two recently released documents shed some light on where Fifth Third is at right now. Merrill Lynch reaffirmed a “sell” recommendation on Fifth Third (Nasdaq: FITB) shares on Nov. 4 and reiterated the sell rating on Nov. 17 and 29. Merrill Lynch analysts noted that the company did not provide a reason for Arnold’s resignation and would not disclose whether it was voluntary.

Merrill Lynch analysts said they viewed Arnold’s resignation as a “significant fundamental negative” for Fifth Third and regarded his loss as “a major void in FITB’s senior management structure,” because Arnold had direct oversight of several fee-producing businesses, including investment advisory, payment processing and mortgage. And as a former CFO of the company, he has had a major role in Fifth Third’s financial management. They also noted that “it seems unusual” Arnold would voluntarily retire at the age of 45.

However, the analysts stated that they don’t think Arnold’s resignation “should logically lead to” increased speculation regarding a potential acquisition.

“If an acquisition of Fifth Third were imminent, near-term, it seems unlikely that Mr. Arnold would either resign voluntarily or would be required to resign,” they stated. “An involuntary resignation would presumably send an unwanted signal of senior management disruption (at Fifth Third) prior to a merger. Thus, it seems unreasonable to conclude that Mr. Arnold’s departure makes an acquisition of Fifth Third more likely.”

Similarly, Prudential Equity Group assigned Fifth Third an “underweight” rating following Arnold’s resignation — a rating Prudential says most closely corresponds with the more traditional “sell” rating. That means analysts believe that a stock of average or above-average risk has the potential to decline 15 percent or more over the next 12 to 18 months.

Arnold’s resignation, noted Prudential’s Michael Mayo, CFA, “adds one more degree of instability at the company.”

On Dec. 1, Moody’s Investors Service revised its outlook on Fifth Third Bancorp from stable to negative, pointing to weaker profitability and capital ratios over the past 18 months. Typically, a negative outlook means it’s likely Moody’s will cut the company’s debt rating in the next 12 to 18 months. But Moody’s noted that despite recent declines in Fifth Third’s financial ratios, the company still remains strong.

Moody’s said that if Fifth Third is willing to accept further declines in profitability and capital ratios in an attempt to grow earnings, then the likelihood increases of a downgrade to its long-term debt, deposit ratings and financial strength rating. That is significant because the Aa2 “high quality” rating the bank holds today is one of the highest a bank can achieve. As a result, when Fifth Third issues a letter of credit, it is considered to be one of the safest, virtually assuring payment on the letter of credit. Debt rating also affects borrowing costs for the bank and can be used as a marketing tool, as well.

According to Moody’s, a rating change is more frequent among bonds of lower ratings than among bonds of higher ratings. Cummings said that even if Moody’s were to take the company’s debt rating down a notch, he doesn’t think it will have a material impact on Fifth Third’s operations or cost of funds. His company and Standard and Poor’s, for instance, have reiterated a hold opinion on shares of Fifth Third. It’s not uncommon for research analysts from different companies to differ in their opinions of a stock, he added.

S&P analysts said they continue to believe that Fifth Third can generate above-average loan growth compared with peers, and can eventually return to its historical levels of profitability.

“However, we now think that this process is going to take longer than we had originally expected, and in the meantime, we do not think the shares are likely to regain their historical above-average valuation,” S&P analysts stated Dec. 3.

Cummings said KeyBanc Capital’s view is that any downgrade would not be significant. “Fifth Third is not hitting on all four cylinders, to say the least, but it’s something they can recover from because these are not credit issues. I will tell you the company is still very profitable; it’s going to earn maybe 16 percent return on equity, it’s credit quality is very solid, and its capital ratios are strong,” Cummings said.

“Fifth Third’s problem is lack of growth; they can’t grow their earnings. The situation is not as dire as it might seem to be on the surface. Once the bank gets a new CFO, that might be the start of a turnaround in the company.”

Analysts say that with Arnold gone, Executive Vice President Kevin Kabat, former president and CEO of Fifth Third Bank West Michigan, is expected to be among the candidates to succeed CEO Schaefer, 59, when he decides to retire.     

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