With Second-Quarter Earnings Coming Thursday, Here's Everything You Need to Know About Fifth Third Bancorp

Let's break down this regional bank to prepare for Thursday's second-quarter earnings release.

Jul 16, 2014 at 6:10AM

Over the next month, banks will be releasing results for the second quarter. In advance of these releases, let's take a moment to review the state of some of these banks as of the end of Q1.

Today, we'll look at Fifth Third Bancorp (NASDAQ:FITB), a $129.6 billion bank headquartered in Cincinnati that's scheduled to release second-quarter earnings on July 17.

When I evaluate banks, I follow a model made famous by former Wachovia CEO John Medlin: soundness, profitability, and growth. As investors, we then look at valuation and the potential for investment after gaining a better understanding for each bank.

Fifth Third Logo Company Website

Source: Company website.

Soundness refers to the bank's asset quality. Generally speaking, this means loans. If a bank makes loans that are never repaid, that bank will fail, and fail quickly. The best banks put risk management first, ensuring that shareholder capital is protected if a portfolio of loans turns sour.

To measure this, we'll look at both non-performing assets and Fifth Third Bancorp's provision for loan and lease losses. A simplified definition of non-performing assets is loans or other assets that have fallen seriously delinquent or are in foreclosure.

The provision for loan and lease losses is a reserve of money that the bank pulls out of its income each quarter to guard against future losses in the loan portfolio. Banks are required by regulation to maintain certain levels of reserves, but within that, management has plenty of wiggle room to over- or under-reserve. Over-reserving increases protection but hurts net income; under-reserving increases risk but keeps net income high.


Source: Company website.

For the quarter ending on March 31, Fifth Third had 0.73% non-performing assets as a percentage of total assets. The FDIC reports that banks with total assets greater than $10 billion on average had 1.5% non-performing assets as a percentage of total assets.

Fifth Third reserved $69 million for the first quarter, which represented 4.8% of operating revenue. That compares with 5% for the $10 billion-plus peer group, according to the FDIC.

For comparison, rival bank BB&T (NYSE:BBT) reserved just 2.7% of operating revenues on a non-performing assets ratio of 0.53%. So while Fifth Third's credit quality is satisfactory, its notable that the bank does appear to trail some of its direct competition in this measure.

After establishing an understanding of a bank's risk culture and soundness, next we can focus on profitability. Any investment in a business is an investment in that company's future earnings, so profitability is a particularly important consideration for any bank investor.

The first question, perhaps most obviously, is if the bank generates a profit at all. According to data from the FDIC, 7.3% of U.S. banks failed to generate a profit at all in the first quarter. That's one in every 14 banks!

For Fifth Third Bancorp, the first calendar quarter of 2014 fortunately wasn't that bad. The company generated total net revenues of $1.4 billion for the quarter -- that is total interest income plus non-interest income minus interest expense.

FITB Net Income (Quarterly) Chart

FITB Net Income (Quarterly) data by YCharts

Over the past 12 months, Fifth Third Bancorp has generated $6.1 billion in total net revenue. Of that revenue, 62% was attributable to net interest income, the difference between interest earned on loans and paid out to depositors. The remaining 38% was through fees, trading, or other non-interest revenue sources.

The bank was able to turn a profit margin of 28% on that revenue. The industry average for large banks was 22% profit margins; BB&T reported 21.95%.

For the first quarter, the company reported return on equity of 8.7%. Of the banks covered in this series of articles, the average return on equity was 8.9%. The FDIC reports that the average ROE for U.S. banks with total assets greater than $10 billion was 9.1%.

Leverage is a double-edged sword for banks and could easily fit into either the soundness or profitability categories. We'll call it a subset of both and discuss it here.

Leverage is just part of the game with banks, so if you're a conservative investor who really focuses on conservative capital structures, the banking industry may not be the best place for your money. Adding leverage is an easy way to juice return on equity, which is generally speaking a good thing. The bank increases assets and thus earnings, while maintaining a lower capital level.

The result is a higher numerator, a constant denominator, and a larger return-on-equity number. The math does the heavy lifting for you.

On the flip side, too much leverage can put the bank on thin ice if the loan portfolio takes a turn for the worse. A stronger equity base protects the bank from bankruptcy and bailouts, two outcomes that are both politically charged and downright terrible for shareholders.

FITB Assets To Shareholder Equity (Quarterly) Chart

FITB Assets to Shareholder Equity (Quarterly) data by YCharts

Banks use all kinds of esoteric and overly complex accounting methods to determine leverage. We'll keep it simple here with an old-fashioned assets-to-equity ratio. The lower the number, the less levered (and more conservative) the bank.

Fifth Third Bancorp's assets-to-equity ratio comes in at 8.7. The average of the 62 banks analyzed in this series of articles was 9.1.

Growth and waluation
Fifth Third Bancorp saw its revenues fall by 2.8% over the past 12 months. That compares with the average 5.7% increase of the 62 banks analyzed.

This change in revenue corresponded with a 10% increase in net income over the same period. The peer set averaged 14.1%. Fifty-four percent of all U.S. banks saw year-over-year earnings growth in the first quarter.

Moving now to valuation, Fifth Third Bancorp traded at a forward price-to-earnings ratio of 12.1, according to data form S&P Capital IQ. That compares with the peer set average of 16.7 times.

Fifth Third Bancorp's market cap is, at the time of this writing, 1.6 times its tangible book value. The peer set average was 1.9. BB&T trades at 2.1 times TBV.

Many investors use a general rule of thumb of buying a bank stock when the price-to-tangible book value is less than 0.5 and sell when it rises above 2. For me, that method is just way too oversimplified.

FITB Chart

FITB data by YCharts

It sometimes makes sense to pay a premium for a bank stock that places a high value on credit culture and asset quality. These banks will survive and prosper while others fall by the wayside. That security can be worth a premium. Likewise, a bank that relies heavily on leverage to achieve above-average return on equity may not be worth the price, even if price-to-tangible book value is low. That risk may not justify even a healthy discount in price.

Based on the factors we've discussed here -- soundness, profitability, and growth -- Fifth Third appears to be undervalued.


The bank earned $0.36 per share in the first quarter. Analyst estimates put second-quarter earnings somewhere around $0.44 per share. Thinking longer term, though, the investment profile for Fifth Third looks bright.

The bank is one of the largest regional banks in the country, which affords it big bank scale with a community bank business model. The bank's asset quality is satisfactory, even though it isn't perfect. Profitability is well above its peers, and even though return on equity trails the peer average, the bank's valuation today at just 1.6 times TBV represents too much of a bargain to pass up. Altogether, Fifth Third is a rock-solid bank with strong fundamentals, and it trades at a discount.

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Jay Jenkins has no position in any stocks mentioned. The Motley Fool owns shares of Apple, Bank of America, and Fifth Third Bancorp and owns shares of Apple and Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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