Fifth Third Seems A Little Underappreciated

By Stephen D. Simpson, CFA | January 21, 2013 AAA

Perhaps Fifth Third Bancorp (Nasdaq:FITB) is a little too solid for its own good right now. With investors worried about narrowing spreads and limited loan growth potential, much interest in the sector seems to be turning toward companies with major expense-cutting and credit improvement stories to tell. While Fifth Third is already in pretty good shape, I think investors may yet be underestimating the core growth potential in this bank.

SEE: The Banking System

Fourth Quarter a Little Messy, but Pretty Solid
Almost every bank with more than $2 billion or $3 billion in net interest income has a relatively complicated earnings report, and Fifth Third is no exception. Depending on the adjustments you make (and what you consider to be "core"), this was either a slightly better-than-expected quarter or a basically in-line quarter.

Adjusted operating revenue rose 9% from last year and about 5% from the third quarter. Net interest income was weak, falling 2% and sub-1%, making Fifth Third a little more consistent with Comerica (NYSE:CMA) than Wells Fargo (NYSE:WFC) or U.S. Bancorp (NYSE:USB). Net interest margin weakened about nine basis points (BPS) to 3.47%, which looks average to low-average this quarter. Average earning assets increased 2% sequentially.

Fee income rose a strong 13% from the Q3, after adjusting for items such as gains on the Vantiv (NYSE:VNTV) IPO, fueled by a 29% increase in mortgage banking and 13% growth in corporate banking fees. Expenses were also higher on an adjusted basis (up about 3%), but the efficiency ratio still improved by about 120 BPS. At about 61%, Fifth Third still has work to do on cost-cutting.

SEE: Analyzing A Bank's Financial Statement

Good Growth - Can Fifth Third Keep It Up?
Loan growth was pretty solid this quarter, with the end-of-period loan balance up 3% from Q3. That's a pretty solid result in this environment, with Comerica and M&T Bank (NYSE:MTB) being two of the only comparables with better growth. Fifth Third continues to see good demand for commercial loans (up 8%) and mortgages, while commercial real estate loan balances declined. Fifth Third also continues to see yields erode, with erosion (to 4.1%) of another eight BPS this quarter.

Fifth Third also continues to see improving credit quality. Non-performing loans declined 11% from Q3, and the non-performing asset ratio improved 27 BPS to 1.51%. That's still a little high, but it's worth noting that it's not a uniform phenomenon - while Florida represents about 7% of the company's loan book, it accounts for 25% of the non-performing assets.

Turning back to the loans, this is one of the bigger questions for Fifth Third in 2013. Can the company continue to post solid loan growth and offset the pricing pressure (shrinking spreads) with volume? While many banks are increasing their focus on commercial lending, I don't believe that competition is quite as fierce in some of Fifth Third's core markets such as Ohio and Michigan, as many banks ran from these markets in pursuit of better growth in the Southeast and Texas.

Not only is business activity picking up in the Midwest, but demand for auto paper in the securitization market is also a positive, as Fifth Third is a significant auto lender.

SEE: The Industry Handbook: The Banking Industry

The Bottom Line
As I have pointed out with other quality regional banks, there are definitely some buying possibilities in this sector right now. Although shrinking interest spreads are likely to crimp growth in 2013, the valuations on long-term performance still look appealing. In the case of Fifth Third, a long-run return on equity (ROE) estimate of 12.50% would support a fair value of about $20 today, while a long-run regression of tangible book value and returns on tangible equity would suggest a fair value in the high teens.

While Fifth Third took its licks in the credit crunch, the bank has done a lot to fix itself since then. What's more, this has become an interesting organic growth story as the bank looks to gain share through branch-building in markets like North Carolina. Plenty of sell-side analysts disagree (projecting long-term ROEs below today's level), but Fifth Third could still offer long-term value for investors.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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