Thursday, September 25, 2003

End of oversight in sight

Fifth Third revamped

By Jeff McKinney
The Cincinnati Enquirer

In wrapping up one of the most challenging times in its history, Fifth Third Bancorp is expected by this weekend to have complied with operational changes demanded by regulators.

The Cincinnati parent of Fifth Third Bank had six months to implement terms of an agreement it reached March 27 with the Federal Reserve Bank of Cleveland and the Ohio Division of Financial Institutions after it was accused of lax accounting in its treasury operations.

The agreement required that Fifth Third solve internal accounting problems and its risk management processes. Regulators will review those measures to see whether the bank has met their terms before removing supervisory oversight.

Among other things, that would allow the bank to resume making acquisitions, a key growth tool the past decade for the $88 billion bank.

As is customary, the Fed declined to comment on the agreement or when its order might be lifted. Fifth Third has said it's making progress on the agreement.

Most banking analysts think that Fifth Third has taken actions to meet the regulators' demands, and they predict that the Fed could end its scrutiny within three months.

The March 27 agreement came after Fifth Third said in November 2002 that it would take a $54 million after-tax writeoff against third-quarter profits that year. The issue involved investments the bank made through its treasury operations, not customer accounts.

How operations changed

Fred Cummings of McDonald Investments in Cleveland estimated that the agreement has cost Fifth Third $18 million to $20 million in pre-tax expenses. That's not much considering that the bank had total expenses of $1.6 billion the first six months of 2003. But that money could have gone to the bottom line, he added.

He and other analysts say Fifth Third has taken several actions to be in compliance. The company has:

• Hired outside consulting firms to examine such things as the bank's management performance, operating functions and structure.

• Invested in new equipment and systems and hired people in various accounting functions to help reduce the chance of such mistakes occurring again.

• Added a compliance/audit officer at each of its banking affiliates, which includes major areas such as Cincinnati, Chicago, Detroit and Indianapolis, to help ensure operating consistency in the entire bank. Those are new positions at Fifth Third.

• Hired Malcolm Griggs, a former risk policy executive from Wachovia Corp., as executive vice president and chief risk officer. His hiring came a few days before the agreement was reached and was something analysts say Fifth Third likely would have done anyway.

Image rehab

The completion of the agreement would end a rough period for Fifth Third, since the accord tarnished its image as one of the nation's best-run and top-performing banks. An end to the agreement also would let it complete its pending $240 million acquisition of Franklin Financial Corp., a bank holding company with assets of about $900 million and nine branches based in Williamson County, Tenn.

Gary Townsend of Friedman, Billings & Ramsey in Arlington, Va., said that from his talks with Fifth Third, the company has done what's needed to comply with the agreement.

"This cost them embarrassment and a monetary loss," he said. "I imagine that they've not only done enough to meet what's been requested, but additional things on their own to prevent this from happening again and make them a stronger company."

The regulatory oversight has caused some investors to become skittish about the stock, even prompting some to file lawsuits. Fifth Third has posted double-digit share-earnings growth the last two quarters and still trades at a much higher valuation compared with similar-sized banks.

Although Fifth Third stock has recovered most of what it lost in market value between November and March - more than $5 billion - its shares have still been hurt by the overhang of the Fed agreement.

Fifth Third stock closed Wednesday at $56.57, down 3.4 percent this year. That compares with a return of 18.5 percent for the Philadelphia Bank Index, which includes Fifth Third and peer banks such as as Bank of America, Bank of New York, Bank One and U.S. Bancorp, said Brad Vander Ploeg of Raymond James & Associates in Chicago.

Analysts' concern about Fifth Third's inability to do deals now is likely among the reasons why the stock is lagging its peer group.

"The Fed thing has clearly created some difficulty for them, particularly with their inability to do deals," Cummings said. "Fifth Third also still trades at a higher multiple than most of it peers... those are some things that have hurt the stock, despite its strong earnings performance."

Cummings has a "buy" rating on the stock and has a 12-month price target on Fifth Third of $70.

Stock surge ahead?

David George of A.G. Edwards in St. Louis said in a report that the agreement is a blemish on Fifth Third's excellent track record but that the market has overreacted to the issue. He also says Fifth Third will become stronger because of it.

"We believe termination of the agreement ... will provide a catalyst for the shares," he said. George has a "buy/conservative" rating on Fifth Third and thinks that it will hit $65 in 12 to 18 months.

But Vander Ploeg has an "underperform" rating on the stock. His view: Fifth Third's traditionally strong earnings have suffered lately, and its strong stock price performance recently has made it what he considers overvalued.

Wall Street analysts also predict that Fifth Third will get back into the acquisition game once the order is lifted, though they're mixed on which banks it might pursue.

Cummings sees Fifth Third going after more banks in the Midwest with assets of $15 billion or less, particularly in Chicago.

Fifth Third entered Chicago in 2001 with its $5 billion acquisition of Old Kent Financial Corp. Fifth Third has 941 branches in eight states, including 584 in Ohio, Kentucky and Indiana.

"Chicago is probably a No. 1 priority right now," Cummings said. "It's a fragmented market with a lot people with a lot of money. There is still a lot of room for growth there."


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