FITB Fifth Third Bancorp

Cincinnati-based Fifth Third Bancorp (FITB) will record a reduction of $68 million in its fourth-quarter 2011 pretax income, the company said on Thursday. The drop in income follows the litigation faced by Visa Inc. (V).

In 2005, some retailers filed lawsuits against Visa, MasterCard Inc. (MA) and several other banks. They accused these credit card companies of preventing retailers to provide cheaper payment options to customers in order to eliminate competition. Therefore, Visa is working to resolve lawsuits.

In mid-December, Visa announced that it will deposit about $1.6 billion in its escrow account to fund its litigation costs. This action is considered equivalent to repurchase of shares of the company. Meanwhile, the company used the funds allocated for the share repurchase program announced in July 2011 and October 2011 to raise the deposit money.

Accordingly, Visa will make the deposit under its previously implemented retrospective responsibility plan (RRP), the terms of which solely affect the financials of the company’s class B shareholders.  When the company funds the escrow account, the shares of class B common stock gets diluted through an adjustment to the conversion rate of the shares of class B common stock to shares of class A common stock.

Apart from funding the litigation escrow account, under the RRP, such action can also be taken when Visa has to arrange funds for its U.S. financial institutions or their associates and successors.

We believe that such an account protects the company’s common shareholders from direct losses. This is not the first time that Visa has entered into such risk-fund back-up arrangements. Besides, Visa stands as a defendant in several state and federal lawsuits filed by individuals and institutions such as interchange litigation where interchange rates are violated, faulty currency conversion practices and pricing structure.

Previously, in 2009, Fifth Third sold its holding of Visa Class B shares entering into a total return swap contract with the sale agreement. The swap contract requires Fifth Third to pay the counterparty if value of the shares diminishes.

Therefore, Fifth Third’s fourth-quarter 2011 non-interest income will be reduced by $54 million, reflecting the company’s accountability related to the swap, according to a Securities and Exchange Commission filing. Moreover, Fifth Third augmented litigation reserve by $14 million. This increase will be an addition to the company’s non-interest expenses in fourth-quarter 2011.

We believe Fifth Third is well positioned to benefit from a rebound in economic conditions along its footprint. Its diverse revenue mix augurs well.  Improved credit metrics are also encouraging. However, reduction in pretax income will have an overall effect on the company’s financial results. Moreover, regulatory issues remain an overhang for Fifth Third.

Fifth Third currently retains a Zacks #3 Rank, which translates into a short-term Hold rating. Considering the fundamentals, we are also maintaining Neutral recommendation on the stock.

 
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