Regional banks have gotten off to a solid start to 2023: The SPDR S&P Regional Banking ETF is up by about 5.3%, outpacing the year-to-date gains of the broader market.
Regional lender Fifth Third Bancorp (FITB 0.22%) has gotten off to an even better start: Its stock is up by about 10% year-to-date, and last month it delivered solid fourth-quarter results and guidance for the full year, which has more or less been the theme in its peer group.
Fifth Third currently trades at about 242% of its tangible book value, or net worth, which is a strong valuation. But I actually think this valuation is artificially high right now and more upside could be merited given the bank's performance.
A solid outlook
There was a lot to like in Fifth Third's fourth-quarter earnings results. The bank generated close to a 19% return on equity, thanks in part to a 5% jump in net interest income (the money banks make on loans and securities after funding those assets).
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Good expense management also helped Fifth Third deliver a 52.6% efficiency ratio. That metric gauges expenses as a percentage of revenue, so lower is better. An efficiency ratio in the low 50s is strong for a regional bank of Fifth Third's size.
But if there was one part of its Q4 report I didn't like, it was that charge-offs in the bank's consumer loan portfolio rose, though they are not at concerning levels by any means. The bank also has a residential solar lending unit that the market likely has some concerns with, given the economic outlook.
For 2023, Fifth Third expects to grow net interest income by 13% to 14% and to grow pre-provision net revenue by 15% to 17%. However, management expects net interest income to fall in the current quarter due to rising deposit costs, so the market may wait before taking the full-year guidance to heart. But overall, the guidance looks pretty solid and consistent with what other regional lenders have forecast.
Assessing the valuation
As I mentioned above, Fifth Third trades at a solid valuation on a price-to-tangible-book-value basis. But it's also artificially expensive because of the way Fifth Third invested its bond portfolio.
Banks had lots of excess liquidity heading into 2022 and not a ton of places to deploy it because loan growth hadn't really come back. So banks poured some of that money into bonds. Institutions can choose to either classify these bonds as "held for sale," meaning they intend to sell them before they mature, or "held to maturity," meaning they intend to hold them until maturity. The values of bonds held for sale are marked to market each quarter and go in as unrealized losses or gains that impact tangible book value per share each quarter. And soaring interest rates have crushed bond values over the past year.
Fifth Third keeps nearly all of its bonds in its available-for-sale (AFS) portfolio, a different choice than that made by most of its peers, so its tangible book value per share has taken more of a hit. At the end of 2022, Fifth Third had about $51.5 billion of AFS securities, up from about $38 billion at the end of 2021, and its tangible book value per share was $14.83, down from $22.58 at the end of 2021.
But as long as the bank doesn't have to sell any of the bonds in its AFS portfolio while they are trading at a loss, it will recoup the lost value as the bonds mature. That would boost Fifth Third's tangible book value per share and make the valuation look much more attractive at the bank's current share price. The only reason the bank would need to sell bonds is if it runs into liquidity issues, which I don't expect to happen given where things are today.
Is there upside?
The market may have some concerns about Fifth Third's consumer loan book or whether it will hit its guidance, but the bank -- like other big regional lenders -- has performed well so far and provided solid guidance.
Some of its peers can surely generate better returns, but its valuation doesn't look nearly as expensive after you back out the unrealized bond losses. These should eventually be recouped, so I think Fifth Third's stock has more room to run.
