FITB Fifth Third Bancorp

We maintain our Neutral recommendation on Fifth Third Bancorp (FITB) based on strong second-quarter 2011 results. The results outpaced the Zacks Consensus Estimate and were ahead of the prior-year quarter as well as prior quarter’s earnings.

In July, Fifth Third reported second-quarter 2011 earnings of 35 cents per share, surpassing the Zacks Consensus Estimate of 27 cents. Earnings beat the prior-year quarter figure by 19 cents per share and prior-quarter by 25 cents.

Quarterly results at Fifth Third reflect a better-than-expected revenue figure backed by fee income growth. Credit metrics improved significantly and operating expenses were low.

We believe Fifth Third’s diverse revenue base would boost its earnings growth. It has expanded its non-interest income base, which now represents nearly half of the company’s revenue.

The company also continues to target a neutral to modestly asset-sensitive position, and we expect it to benefit from an eventual rise in interest rates. Net interest income is also expected to benefit from the maturing CDs and trust preferred securities (TRUPs) redemptions in the second half of the year.

Fifth Third’s priority has consistently been on deposit growth. The company’s expansion strategy has clearly been retail-oriented, involving a combination of de novo branching and acquisitions. Fifth Third acquired 9 branches from First Horizon National Corporation while completing its acquisition of First Charter Corporation, a regional financial services company, in 2008.

The company also acquired all the deposits of Florida-based Freedom Bank through a Federal Deposit Insurance Corporation (FDIC) deal in late 2008. Going forward, we expect such strategic acquisitions to support the company’s revenue stream.

Fifth Third enjoys a strong capital position, following the repayment of the bailout money that it received as part of its participation in the Treasury’s Troubled Asset Relief Program (TARP). The company increased its dividend in the first quarter of 2011 and maintained the same level in the second quarter of 2011 as well.

However, currently the company has increased third-quarter 2011 cash dividend on its common shares to $0.08 from $0.06. We expect the company to continue deploying capital through dividend payment, share repurchase and acquisitions going forward.

On the flip side, the weakness in the overall economy and in the real estate market, including specific weakness within Fifth Third’s geographic footprint, has adversely affected the company. Geographically, the company continued to experience stress in Michigan and Florida due to the decline in real estate values.

Though the general economic conditions started to improve during 2010, and the economy continued to show signs of stabilization, we would like to see meaningful improvement in the economic indicators before becoming extremely positive on the stock.

Moreover, regulations, such as the Durbin amendment and Reg E, are likely to hurt the company’s revenues and earnings. Management expects the Durbin Amendment to reduce Fifth Third's debit interchange fees by about 50.0% on a gross basis, with a quarterly impact of approximately $30.0 million before any mitigating factors. Moreover, compliance cost is also expected to increase.

We believe Fifth Third is well-positioned to benefit from a rebound in economic conditions along its footprint. Its diverse revenue mix and solid capital position also augur well going forward. However, regulatory issues remain an overhang.

We would like to see a substantial top-line improvement before becoming extremely positive on the stock. Yet, given the current economic environment and the regulatory issues, any revenue expansion remains elusive in the near term.

Fifth Third currently retains its Zacks #4 Rank, which translates into a short-term Sell rating. However, Fifth Third’s closest competitor – M&T Bank Corp. (MTB) retains a Zacks #3 Rank (a short-term Hold rating).

 
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