The banking stocks have performed quite well this year. Some of the sector leaders such as JPMorgan Chase (JPM), Citigroup (C) and Wells Fargo (WFC) are up substantially. These three are up 18.8%, 26.1% and 24.2% respectively year to date. Many investors I know trade and invest in these types of stocks for growth and dividends. However, what the same investors often miss are potentially extremely rewarding small, regional banks that often offer growth AND pay excellent dividends. Smaller banks can be much easier to follow compared to larger banks, as they are primarily balance sheet based businesses. When the balance sheet of a local bank is appealing, more than likely the earnings report will be as well. The relation is just stronger and there are less variables to consider compared to the larger competitors. Recently, I began to seek out smaller regional banks that could help diversify my financials portion of my portfolio. In seeking out a potential regional bank to help diversify the financial portion of my portfolio, I came across a very interesting and rather under-studied Fifth Third Bancorp (FITB).
The Bank Has History
FITB is headquartered in Cincinnati, OH and is among the largest money managers in the Midwest region of the United States. The bank has some serious history. It has been in existence for over 140 years, and has expanded considerably since its beginning. Like many other regional banks, FITB provides many financial services, including commercial banking, branch banking, consumer lending, and investment advisement. The commercial banking segment is pretty standard as it offers credit intermediation, cash management, and financial services; lending and depository products; and foreign exchange and international trade finance, derivatives and capital markets services, asset-based lending, real estate finance, public finance, commercial leasing, and syndicated finance for business, government, and professional customers. The branch banking segment provides deposit, loan, and lease products to individuals and small businesses. This includes checking and savings accounts, home equity loans and lines of credit, credit cards, and loans for automobiles and personal financing needs, as well as cash management services. The consumer lending segment engages in mortgage and home equity lending activities, such as origination, retention, and servicing of mortgage and home equity loans as well as other indirect lending activities, which include loans to consumers through mortgage brokers and automobile dealers. Finally the investment advisement segment offers investment alternatives for individuals, companies, and not-for-profit organizations. It offers retail brokerage services to individual clients, and broker dealer services to the institutional marketplace. This segment also provides asset management services; holistic strategies to affluent clients in wealth planning, investing, insurance, and wealth protection; and advisory services for institutional clients, including states and municipalities.
The Bank Is Growing, But Has Much More Room To Expand
Starting off the bank only had one branch in Cincinnati, OH. Over a 50 year period that number expanded to 10. In the next thirty years that number tripled, and tripled again in the following twenty years. Fast forward another 50 years and the bank has seen exponential growth. FITB along with has agreements with 18 affiliates managing 1,326 full-service Banking Centers, including 104 BankMart locations open seven days a week inside select grocery stores and 2,433 ATMs in Ohio, Kentucky, Indiana, Michigan, Illinois, Florida, Tennessee, West Virginia, Pennsylvania (Figure 1). The company's expansion strategy has enabled the company to significantly reinvigorate deposit and loan growth beyond what it had been experiencing in its slower growth traditional markets. One issue with rapid expansion into new markets is the fear of expenses ballooning out of control. Despite the branch expansion program, the company has controlled expenses resulting in an efficiency ratio that remains among the best in the industry.
Turning to the statistics of the stock, FITB has a price to book ratio of just 1.23. FITB currently trades at 10.0 times earnings, and pays a very sustainable 2.51% dividend yield. FITB currently trades at $19.10 with average daily volume around 7.5 million shares exchanging hands daily. The balance sheet of the company is fantastic. When we dig deeply into the numbers, we find that the company has around $4.43 billion in cash, which boils down to be $5.20 in cash per share. The company has moderate debt of $10.6 billion related to expansion and repurchase activities. Looking into the dividend a bit more, FITB has paid a dividend every quarter since 1990. In 2009, when the quarterly dividend was cut to just a penny a quarter. This cut was done as a precautionary measure in case the financial crisis got much worse. It has been raised to 12 cents a quarter, and the company will likely raise it again in 2014 as earnings and revenues continue to grow. The next dividend will be paid in October and will likely be 12 cents once again.
Figure 1. Fifth Third Bancorp's Regional Reach
2012 Was A "Game-Changer" For FITB; Exceptional Growth And Results Delivered
FITB's 2012 financial results reflected its strong competitive position and profitable business model. FITB reported full year net income available to common shareholders of $1.5 billion, the highest since 2005, and net revenue of $2.5 billion. Although the low interest rate environment and other environmental costs present near-term challenges to all of the banks, FITB's return on assets of 1.3% was within the company's long-term target range for a more normalized environment (1.25%-2.10%), and return on average common equity was 11.6%, compared with 9.0% for 2011. One important metric, the bank's efficiency ratio was 61.7%, which is incredibly strong.
Credit Metrics Improved
Credit metrics improved across the board and it was impressive. Full year net charge-offs were $704 million, which was a decline of 40% to 85 bps of average portfolio loans and leases, the lowest level for FITB in five years. Nonperforming assets, including those held for sale, were $1.3 billion which was a drop of $639 million, or 33%. Total loan delinquencies (excluding nonaccrual of $525 million) were at their lowest level since 2004. This major improvement in credit trends led to a reduction in loan loss reserves of $401 million during 2012, while at the same time producing strong coverage ratios, at 2.16% of portfolio loans and 180% of nonperforming portfolio loans.
These numbers caught my eye. Total loan growth was 6% in 2012 and was driven by higher origination volume particularly in commercial and industrial (C&I), residential mortgage and automobile loans. Average commercial loans increased 6% from 2011, with average C&I loan growth of $4 billion, up 15%. In 2012, FITB expanded the commercial capabilities by establishing a specialized energy industry lending group and remained focused on the healthcare industry, with continued investment in new products to help hospitals and medical practices streamline their collection cycles and accelerate their cash flows.
Average consumer loans increased 5% from 2011, largely due to average residential mortgage loan growth of 18%. FITB mortgage business benefited from increased refinancing due to low rates and originations related to the government's HARP 2.0 program, which represented nearly 20% of total mortgage originations. As 2013 progress I continue to see opportunities in the mortgage business with the ongoing housing market recovery and across FITB as a whole as it works to build relationships with many of their customers. Furthermore, within the consumer portfolio, average auto loans increased 4% from 2011, and benefited from continuous expansion efforts to build a presence in the indirect auto market and FITB now reaches customers in 45 states. One final positive note, average credit card balances increased 5% from 2011, creating another source of revenue growth here into 2013.
The Vantiv IPO
Another significant transaction for FITB in 2012 was Vantiv, Inc.'s (VNTV) IPO. This IPO was part of a process that began in 2008-09 when FITB decided to sell an interest in their Fifth Third Processing Solutions. At the time FITB management likely were under the impression that the growth of the business would be accelerated by enabling it to operate independently, because that is exactly what has happened. VNTV has nearly doubled its revenue since 2008. VNTV has also benefited from several acquisitions that would have been difficult to accomplish had the processing business remained under the full purview of FITB. FITB holds roughly a 1/3 stake in VNTV, which allows it to strengthen its core business and accelerate the bank's growth. However, the bank plans to reduce this stake by selling some shares to raise cash for share repurchase programs and other general administrative uses. This liquidity adds an extra layer of security to shareholders, as it provides the bank with some financial flexibility.
Things Still Look Great -- Recent Quarterly Report
FITB's recent reports have been very strong. The most recent quarter ending in June was recently reported on July 18th, 2013. The numbers looked good right from the start as net income came in at of $603 million, compared with net income of $422 million in the first quarter of 2013 and net income of $385 million in the second quarter of 2012. This is an amazing 56.6% growth over the comparable 2012 quarter. After preferred dividends, second quarter 2013 net income available to common shareholders was $594 million, or $0.66 per diluted share, compared with first quarter net income to common shareholders of $413 million, or $0.46 per diluted share, and net income to common shareholders of $376 million, or $0.40 per diluted share, in the second quarter of 2012. This is an impressive 65% increase from the comparable 2012 quarter.
Much like the story for the game changing year in 2012, 2013 is shaping up in the same regard. Return on assets were 1.98%, while return on average common equity was 17.6% and the return on average tangible common equity was 21.6%. All metrics improved from the comparable 2012 quarter. Net charge-offs were $112 million (0.51% of loans and leases) vs. the first quarter 2013 which saw $133 million (0.63% of loans and leases) and the comparable 2012 quarter which saw net charge offs of $181 million (0.88% of loans and leases). Average loan and lease balances (excluding loans held-for-sale) increased $804 million, or 1% sequentially and increased $4.1 billion, or 5%, from the second quarter of 2012. Period end loan and lease balances (excluding loans held-for-sale) increased $1.4 billion, or 2% sequentially and increased $4.7 billion, or 6%, from the comparable year ago quarter. Turning to commercial lending, average commercial portfolio loan and lease balances were up $902 million, or 2%, sequentially and increased $3.6 billion, or 8%, from the second quarter of 2012. Average commercial and industrial (C&I) loans increased 3% sequentially and increased 15% compared with the second quarter of 2012.
Second Quarter Deposit Activity
There was deposit growth as well. Average core deposits increased $617 million, or 1%, sequentially and increased $3.6 billion, or 4%, from the second quarter of 2012. Average transaction deposits, which are included in core deposits, increased $740 million, or 1%, from the first quarter of 2013 primarily driven by higher demand deposits and money market balances, partially offset by lower interest checking and savings balances. Year-over-year transaction deposits increased $4.1 billion, or 5%, driven by higher money market and demand deposits, partially offset by lower savings and interest checking balances. Commercial average transaction deposits increased 1% sequentially and increased 4% from the previous year. Sequential performance reflected higher foreign office, demand deposit, and money market balances partially offset by lower interest checking balances. Year-over-year growth was primarily driven by higher inflows to demand deposit and money market account balances. Average public funds balances were $5.2 billion compared with $5.5 billion in the first quarter of 2013 and $5.7 billion in the second quarter of 2012.
Finally, during the quarter, FITB repurchased another $26 million worth of its stock.
FITB is a strong regional bank that continues to grow loans and deposits. It has emerged from the financial crisis stronger than ever, and has a lot of room to expand its interests throughout the United States. In the most recent quarter, pretty much every asset quality indicator improved compared to the year ago quarter. This strong regional bank is under-covered in the financial analysis world. There are very few analytic pieces on this stock in the financial literature. The company has a large buyback program which has helped share prices and reduced the available share count, improving shareholder value. FITB has a fantastic balance sheet and pays a reliable 2.5% dividend yield. This dividend has grown steadily since the financial crisis and I expect it to be raised again soon. As the regional banks and FITB in particular continue to expand and improve performance, I expect significant stock price appreciation and dividend growth in the coming years if these kinds of results continue to be delivered. In my opinion, the stock could return to its pre financial crisis price levels by 2015, representing a double in the stock price or more if it returns to the $40.00 range. Considering that management is firing on all cylinders, growth is very strong and return on assets continues to improve, FITB could have what it takes to justify a double in price in the next two years.