By Jeff McKinney
The Cincinnati Enquirer

A federal and state investigation of Fifth Third Bancorp could tarnish the Cincinnati banking giant's image as one of America's best-run banks, weaken its stock price and hurt its ability to keep growing rapidly by acquiring other banks.

Fifth Third, highly regarded by Wall Street for its ability to boost revenues and maintain one of the industry's cleanest balance sheets, said Friday in a regulatory filing that investigators are studying an accounting error that forced the bank to take a $54 million charge in the third quarter.

Shares in Fifth Third Friday took their largest nosedive in 12 years, closing down 8 percent for the day, after the bank said the U.S. Securities and Exchange Commission, the Federal Reserve Bank of Cleveland and the Ohio Department of Commerce were conducting an informal investigation of the accounting issue.

"People are concerned because of the uncertainty of what's going on," said Fred Cummings, an analyst at McDonald Investments in Cleveland. "Fifth Third is the type of company that can't afford to make mistakes like this."

The bank is cooperating with the probe. Paul Reynolds, Fifth Third's counsel, said the money in question involved the bank's investments and not customer accounts. He said the bank disclosed the investigation - something it was not required to do in the case of the Fed's involvement - because of the attention recently paid nationally to corporate accounting matters.

The SEC told Fifth Third Tuesday that it was opening the probe, to study the charge and whether there were weaknesses in financial controls within Fifth Third's treasury or trust operations.

The Cleveland Fed told the bank Nov. 7 in a supervisory letter to put a temporary hold on all acquisitions, an action that also was disclosed Friday.

Acquisitions have helped Fifth Third become the nation's 15-th largest bank and a dominant regional Midwestern bank the past couple of years. The Fed's action delays Fifth Third's pending $240 million stock acquisition of Franklin National Bank in Tennessee.

Fifth Third officials, including president and CEO George A. Schaefer Jr., told the Enquirer last month they were hunting for more deals, and a lengthy hold on acquisitions could hurt its growth plans. Rivals, for example, could scoop up potential targets for acquisition while the probe continues.

News of the investigation raised concerns on Wall Street about how the bank, which has $78 billion in assets and operations in eight states, is managing some investments and whether there are any other hidden blunders in its books.

"This is not a life-threatening issue for the company, but in the near term, the stock will stay under pressure, until some of these issues are resolved," said Bradley Vander Ploeg, an analyst with Raymond James in Chicago. He estimates 75 percent of Fifth Third assets have come by way of acquisitions in the past 10 years.

Fifth Third management told one Wall Street analyst, Jennifer Thompson of Putnam-Lovell NBF in New York, that the bank is confident it can resolve the Fed issue as early as next month. Bank officials added the investigation won't hurt the bank's ability to boost profits in the long term and that they're confident the bank has sufficient internal controls to satisfy the inquiries.

"We don't see this affecting our earnings or revenue growth at all," said Mr. Reynolds. "Our main focus is working with the regulatory agencies to give them what they requested on the bank's operations to get these issues resolved quickly."

The bank did not make Mr. Schaefer available for comment.

Mr. Reynolds said the investigation wouldn't delay the bank's plans to open or expand 100 branches in seven states by late 2003.

No officials of the SEC, the Fed or the state could comment on the investigation.

The investigation is significant for Fifth Third in part because it could reduce the premium value of the bank's stock - an attribute that has made Fifth Third an attractive suitor when courting other banks for acquisition.

Fifth Third, which has made more than 60 acquisitions in the last 12 years, has one of the highest price-to-earnings ratios in the banking industry. It has posted higher earnings per share over the past 27 consecutive years, something unmatched by most U.S. banks.

"Ultimately, long term this could be a bigger issue, because Fifth Third has partially got a significant premium in the market because of their spotless reputation but this certainly blemishes it somewhat," said Mr. Vander Ploeg, who downgraded Fifth Third's stock from "strong buy" to "market perform" on Friday. "While it could still trade at premium to the group, it's unclear how much (of a premium) that will be. It won't trade at the level that it was before."

"There should be no material impact to earnings related to the regulatory action," Mr. Thompson, the Putnam-Lovell NBF analyst, wrote in a report issued Friday. "Nonetheless this a black eye for a company that has been typically seen as the model bank."

The accounting error occurred in August, Fifth Third said. It discovered it in September and reported it to the SEC Sept. 10.

In that report, Fifth Third said some of its investments had been impaired or rendered noncollectible. The problem involved investments that may not be assets as they were recorded, Mr. Reynolds said.

In questioning a number of accounting checks and balances, the Cleveland Fed and the state are looking into areas that are the responsibility of the board of directors' audit committee.

Joan Herschede, CEO of a Cincinnati investment company and a member of the audit committee, declined comment Friday when reached at home. "I'll let George (Schaefer) and the management handle that," she said.

The committee's chairman, Dennis J. Sullivan Jr., a former Cincinnati Bell chief financial officer working for Dan Pinter Public Relations Inc., did not respond to a request for an interview. Western-Southern Life Insurance CEO John F. Barrett, also a member of the audit committee, also did not respond to a request for an interview.

Letters to companies from the SEC about financial disclosures aren't uncommon, and in the days before Enron and WorldCom most companies wouldn't have disclosed them.

But now, after those scandals and the passage of the federal Sarbanes-Oxley Act of 2002 on corporate governance, "people are hypersensitive to any kind of accounting irregularity," said Steve Wyatt, head of the department of finance at the University of Cincinnati.

"Probably, a few years back, before the Enrons and the WorldComs and all that, an event of this type wouldn't have gotten a lot of scrutiny," he said.

The supervisory letter from the Fed, however, appears more serious. It raises questions about a range of internal financial controls at Fifth Third.

Mr. Wyatt said it's possible that write-offs over devalued investments could exceed the $54 million that Fifth Third had set aside for those losses. If that happens, it could affect the value of Fifth Third's stock, and any acquisitions based on the stock would have to be revalued.

The situation could mirror what happened to Procter & Gamble Co. in September. The Cincinnati consumer products company was on the verge of signing a multibillion-dollar outsourcing deal with Electronic Data Systems Corp. that was based in part on EDS stock. But as P&G was about to close the deal, EDS announced it would not meet third-quarter financial goals, and its stock price plunged by half. P&G then called off the deal.

The regulators want to make sure Fifth Third's investment losses "are not wider than they appear to be," Mr. Wyatt said.

Whether or not this is as serious as it might seem, "I'm sure Fifth Third is taking this very seriously, and I'm certain the shareholders are watching to see how Fifth Third executives and the board react to these inquiries," said Jim Cummins, a lawyer and corporate governance expert for the law firm Waite Schneider Bayless & Chesley.

"It's way early here, but I think Fifth Third acted responsibly in moving this information out to the public."

Staff writers John J. Byczkowski and Cliff Peale contributed to this report

E-mail jmckinney@enquirer.com