The decision by Fifth Third Bancorp
The drop in earnings is just the latest disappointment for Fifth Third's shareholders. With more than 1,000 branches located primarily in the Midwest, this bank was once considered a favorite of investors for its successful sales culture and effective expense controls. But demographic trends and increasing competition have made growth harder to come by in recent years. Like most banks, Fifth Third has also suffered lately from an interest rate environment that has hurt its net interest income. In Fifth Third's case, however, a poorly managed balance sheet compounded those interest rate problems. The losses taken in the fourth quarter are the result of management's efforts to restructure the balance sheet in order to achieve an asset/liability profile that is better suited to the bank's operating requirements.
Low-yielding, fixed-rate investment securities had made up a large percentage of Fifth Third's interest-earning assets over the past several years. That asset mix became unfavorable when short-term interest rates began to rise, and the liabilities side of the ledger further complicated the bank's problems. Fifth Third had relied heavily on wholesale borrowings, as opposed to less expensive customer deposits or other funding sources. The consequence of the bank's asset/liability profile was narrow interest rate spreads and added pressure on the net interest margin. In November, the bank began to restructure its balance sheet by selling more than $11 billion of investment securities from a portfolio of interest-earning assets that, as of the end of the third quarter, had totaled more than $95 billion. Concurrent with these substantial changes to the asset side of the ledger, Fifth Third repaid $8.5 billion of outstanding debt.
The losses associated with these and other balance-sheet changes reduced earnings by nearly $0.53 per share. Losses of that magnitude are tough medicine, but they promise to improve the bank's health in the long run. Following the restructuring, fourth-quarter net interest income increased by 3% to $744 million. Fifth Third's net interest margin also improved from the previous quarter, to 3.16% from 2.99%. Management expects that the net interest margin will reach 3.35% to 3.45% in 2007.
Management's outlook for 2007 is positive, but easy comparisons should help management deliver strong profit growth. At a recent share price of $40, Fifth Third is trading at a richer price-to-earnings multiple than rivals such as KeyCorp
Fifth Third, however, has some unique strengths that would make it an attractive long-term holding. Its decentralized affiliate model has enabled the bank to win dominant market shares in many smaller markets. Its cultural emphasis on cost containment has allowed it to achieve efficiency ratios that have been the envy of many competitors. It also has an electronic payments processing franchise that has delivered strong growth and steady profits. During yesterday's conference call with analysts, management described a new effort to improve retail customer retention rates that should translate into increased profitability.
With much of the hard work in Fifth Third's turnaround now completed, investors might want to begin looking for a buying opportunity in the company's stock.
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Fool contributor Michael Leibert welcomes your feedback. He does not have a position in any of the companies named above. The Fool has a disclosure policy.
