Neutral on Fifth Third Bancorp

We are reaffirming our long-term Neutral recommendation on Fifth Third Bancorp ( FITB - Analyst Report ) , based on its fundamentals and capital redeployment measures amidst the current macroeconomic environment.

Aided by gains on the valuation of warrant that it holds in Vantiv Inc. ( VNTV - Snapshot Report ) , Fifth Third posted improved earnings in the second quarter of 2012. Fifth Third reported net income of $376 million or 40 cents per share in the reported quarter, compared with $328 million or 35 cents in the year-ago quarter. Excluding that gain, earnings came in at 36 cents per share, a penny ahead of the Zacks Consensus Estimate.

Fifth Third experienced a year-over-year increase in mortgage banking income while provisions for loan losses reported a decline. Revenue was better than expected, credit metrics improved while growth in retained earnings attributed to Fifth Third’s enhanced capital ratios.

Fifth Third has recently declared a 25% hike in its quarterly dividend. Moreover, last month the company announced a new share buyback authorization of 100 million shares subsequent to the Fed’s approval after a review of its resubmitted capital plan. This justifies its capital strength.

As a matter of fact, in March this year, the Fed’s objection to a number of elements in Fifth Third's capital plan, including increases in its quarterly common dividend and the initiation of common share repurchases, had put the company on the back foot and weakened its competitive position to some extent. Therefore, a positive development on that front is encouraging and will inspire investors’ confidence in the stock.

Though a number of Wall Street biggies such as U.S. Bancorp ( USB - Analyst Report ) and Wells Fargo & Co. ( WFC - Analyst Report ) , passed the stress test with their proposed capital plans earlier this year, companies such as Fifth Third and Citigroup Inc. ( C - Analyst Report ) faced a setback as the Fed objected to their capital plans.

Also, Fifth Third’s traditional commercial banking franchise, diverse revenue mix and improved asset quality serve as positive catalysts. However, pressure on net interest margin amidst a low interest rate environment, regulatory headwinds, competitive pressure and anticipated rise in repurchase expense would temper any robust improvement in profitability.

Hence, the risk-reward profile seems balanced for Fifth Third and therefore our long-term Neutral recommendation is reiterated.

However, Fifth Third currently retains its Zacks #2 Rank, which translates into a short-term Buy rating.