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Neutral Stance on Fifth Third

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We are reiterating our Neutral stance on Fifth Third Bancorp (FITB - Free Report) following a detailed analysis of the company’s fundamentals and its recent announcement regarding the Vantiv Inc. stake sale as well as balance sheet optimizing efforts and liability cost reduction moves.

Fifth Third came up with decent third-quarter adjusted earnings of 42 cents per share, exceeding the Zacks Consensus Estimate of 39 cents. Results also came in ahead of the year-ago quarter earnings of 40 cents. Better-than-expected results reflect improved net interest and non-interest income. Moreover, enhanced credit quality was a positive. However, higher expenses were the dampeners.

Last week, Fifth Third announced that it is likely to recognize a pre-tax gain of approximately $140 million (around $91 million after-tax) in the fourth quarter of 2012 from the sale of its 15% stake in Vantiv Inc. The proceeds would help Fifth Third buy back its own common shares.

Further, Fifth Third decided to prepay $1 billion of FHLB term debt as part of its efforts to optimize balance sheet and liability costs. The maturity date of the debt was January 5, 2016.

It would lead to a prepayment charge of around $135 million pre-tax, while net interest savings through the maturity date is likely to be around the same amount. This would reflect a benefit of around $40–45 million in annual net interest income and a gain of about 4 basis points in net interest margin.

Going forward, we believe that with a diversified traditional banking platform, Fifth Third remains well poised to benefit from a recovering economy along its footprints. Its traditional commercial banking franchise, diverse revenue mix, improved credit quality and enhanced capital position serve as positive catalysts for the stock. Further, we believe that its capital deployment activities will boost shareholders’ confidence in the stock.

However, the tepid economic growth and low interest rate environment are the concerns for Fifth Third’s top-line expansion. The low rates will create asset pricing pressure, and hence growth in net interest margin is expected to remain moderate. Additionally, in the midst of a protracted economic recovery and regulatory changes, growth in fee income is likely to bear the brunt in the forthcoming quarters. However, mitigation efforts are expected to help recoup some losses.

Also, regulatory issues are a concern for Fifth Third, given its potential impact on the company’s profitability through increased costs, limited fee generation opportunities as well as reduced flexibility with respect to its business. While the motive behind such measures is to enhance banks’ business models so that these become self-sufficient over the longer term, the cost of compliance will likely increase and temper profitability in the near-to-mid term.

In addition, we believe that the company’s flexibility with respect to its investments and lending volumes would be limited in the medium term, given the stricter capital norms and increased reserves that the regulators are proposing to align with the Global standards.

Therefore, we believe that the risk-reward profile for Fifth Third is currently balanced. Hence, we have reaffirmed our Neutral recommendation on the stock. Also, Fifth Third currently retains its Zacks #3 Rank, which translates into a short-term Hold rating. Among its peers, Comerica Inc. (CMA - Free Report) and KeyCorp (KEY - Free Report) also have a Zacks #3 Rank.

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