Fifth Third Bank Gets Big Boost From Mortgage Refinancings, Growing Loan Portfolio
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Earlier this spring, Fifth Third Bancorp (NASDAQ: FITB) presented at the UBS Global Financial Services Conference, along with much of the financial world. In any such presentation, I look for three things: a review of the economic elements affecting the bank, what the bank is doing to respond, and how the bank's metrics compare not just with its own history, but with its peers'. Fifth Third did not disappoint. This big, Cincinnati-based regional has led its geographic competitors in recovering from last decade's credit and banking crisis, and it has a justifiable sense of confidence.
First, the big macro issue affecting all banks has been and continues to be historically low interest rates, combined with sluggish economic growth at best. Among the symptoms of this illness are falling interest revenue, falling net interest margin, and higher expense ratios. Fifth Third is utilizing the one and only means that effectively fights this macroeconomic trend; it is growing its loan portfolio. Fifth Third's commercial and industrial (C&I) loan growth was up 6% measuring from the first quarter of 2011 through the first quarter of 2012. Growth in that sector is critical, as the C&I portfolio at the close of the first quarter was 68% of Fifth Third's total loan portfolio, compared to its peer bank average of 62%. The banks Fifth Third regards as its “peers” include all of the nation's larger regional banks, such as U.S. Bank (USB), PNC Financial (PNC), SunTrust Bank (NYSE: STI), Regions Financial (NYSE: RF) and Wells Fargo (NYSE: WFC).
Maybe the best news from Fifth Third CEO Kevin Kabat was that the pressure on the net interest margin seemed to be lessening over the past two quarters. If the Federal Reserve's extension of the Twist program succeeds in further reducing longer term interest rates, any gains in net interest margin will quickly be reversed. Fifth Third's net interest margin in the first quarter of 2012 averaged 3.61%, down ten basis points from the year ago quarter, and also down six basis points from the 4th quarter of last year.
But the success story of the first quarter, and I believe the main driver of profit growth this year, is the flood of mortgage refinancings that have come in due to the low interest rate environment. Mortgage banking revenue was double in the first quarter of 2012, at $204 million, what it was a year earlier. A lot of these refinancings are being done through the HARP Program, and Fifth Third anticipates very few of these to be prepaid.
Possibly the biggest short term issues for many consumer banks right now are demands from Fannie Mae (FNMA) and Freddie Mac (FMCC) to be reimbursed due to fraudulent mortgage applications. Management views it likely that demands of about $20 million per quarter will be made, an amount the bank calls “manageable.” Common among regional banks, Fifth Third has very limited direct exposure to Europe, and its exposure to European banks totals less than $100 million. Fifth Third, as befits a fairly conservative and well managed bank, has capitalization ratios already in excess of anticipated Basel III requirements.
In the first quarter of 2012, Fifth Third posted earnings of $421 million, or $0.45 per share. This was more than three times the earnings posted in the first quarter of 2011, and 37% more than the fourth quarter of 2011. Absent a one-time, $88 million gain from the initial offering of Fifth Third's payment processing arm, Vantiv (VNTV), the earnings gain would still have been over double the previous year's, but would only have been 7% higher than the preceding quarter. A lot of the easy profit gains from lower provisions for reserves are behind Fifth Third, who, with their new mortgage and C&I loans, will be raising rather than lowering loss provisions going forward. I look for Fifth Third to settle into quarterly earnings, absent one-time factors, averaging 1.15% to 1.30% of assets going forward. Much of the earnings improvement will come from management's stated goal of lowering the expense ratio down to the mid 50% range.
Analysts see second quarter earnings of about $0.36 per share, one penny per share more than the first quarter, absent the one-time Vantiv gain. Full year earnings from continuing operations should be about $1.55 per share, up from $1.18 per share in 2011. 2013 and beyond will depend upon loan growth and interest margin expansion. I like Fifth Third as a conservative investment, as it has a history of knowing how to exceed the performance of other banks within its footprint. Fifth Third is generally liked by analysts, with Matthew Burnell of Wells Fargo recently upgrading Fifth Third to outperform, along with SunTrust.
Other large banks like U.S. Bank and Wells Fargo are more profitable than Fifth Third, but the market has largely priced that profitability into their stock prices. Regions Financial and SunTrust are among the banks that reeled from housing busts in South Florida and have not fully recovered as yet. One big reason I like SunTrust is because I believe its geographic area will outperform the rest of the country over the long term. I do not believe Fifth Third, located in the lower Great Lakes area, has that advantage.
Regions has recently gotten my attention as a particularly attractive play, as it continues to recover from its long wrestling match with weak finances and a lousy housing market. It issued a large public offering and sold its Morgan Keegan brokerage subsidiary in order to pay back its TARP loans; with that done, management can focus again on working to grow the bank's assets and improve its profitability.
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