Fifth Third Bancorp (FITB) has turned to profitability in the second quarter of 2010 after reporting losses in the last three quarters. The company reported a net income of $130 million or 16 cents per share, well ahead of the Zacks Consensus Estimate of 2 cents.

Results also compare favorably with a loss of $72 million or 9 cents per share in the prior quarter. However, in the prior-year quarter, Fifth Third reported a net income of $856 million or $1.15 per share, as it benefited from an asset sale. The company experienced a pre-tax gain of $1.8 billion related to the processing business sale.

The better-than-expected results at Fifth Third were primarily driven by lower loan loss provisions as the credit metrics witnessed an improvement in the quarter. Though expenses remain controlled, the lack of loan demand and thereby a drop in interest income was on the downside.

Credit Quality

Fifth Third’s credit metrics continued to improve during the quarter. Net charge-offs declined 25% sequentially to $434 million, representing the lowest level experienced since the first quarter of 2009. Net charge-offs were 226 basis points (bps) of average loans and leases, down 75 bps sequentially. Overall loss experience continues to be driven by commercial and residential real estate loans in Michigan and Florida.

Nonperforming assets as a percentage of related assets were 3.87%, down 15 bps sequentially. Provisions for loan losses were $325 million, down 45% sequentially.

Capital Ratios

Fifth Third’s capital ratios improved in the quarter. On a sequential basis, Tier 1 common equity ratio increased 25 bps to 7.22%, while Tier 1 capital ratio were up 35 bps to 13.75% and total capital ratio expanded 56 bps to 18.11%. As of June 30, 2010, book value per share was $12.65 and tangible book value per share was $9.51, compared with the prior-quarter book value per share of $12.31 and tangible book value per share of $9.16.

Behind the Headline Numbers

Fifth Third continued to experience a weak loan demand and excess liquidity, which resulted in a 2% sequential decline in net interest income to $887 million and a 6 bps drop in net interest margin to 3.57%. Average portfolio loan and lease balances declined 2% sequentially. However, average core deposits increased 1% sequentially.

Non-interest income of $620 million was down 1% sequentially. The decline was driven by a drop in mortgage banking revenues though an increase in corporate banking revenue, card and processing revenue and deposit fees partially offset that decrease.

On the positive side, Fifth Third’s non-interest expense decreased 2% sequentially, as credit-related expenses fell in the quarter, though higher salaries, wages and incentives partially offset the decline.

Our Take

Fifth Third results were in line with the overall industry, which witnessed big companies such as JPMorgan and Chase Company (JPM), Bank of America Corporation (BAC), Citigroup Inc. (C) and U.S. Bancorp (USB) reporting better-than-expected earnings on improved credit quality.

However, the financial reform law is expected to increase the compliance costs of Fifth Third. Nevertheless, the capital market activities of banks are of heightened focus in the reform law, which is expected to partially restrict the proprietary trading of commercial banks. Additionally, dealing in derivatives — which are used to hedge risks or speculate the future value of assets — would also be limited.

We expect these actions to have a significant impact on the profitability of a number of other commercial banks including JPMorgan, Citigroup, Goldman Sachs (GS), Bank of America, Wells Fargo (WFC) and Morgan Stanley (MS), who have such activities.

In the upcoming quarters, we expect Fifth Third’s diverse revenue stream, opportunistic expansions and cost containment measures to support its earnings. Though credit quality trends are improving, we would be encouraged to see a growth in loans. But, given the slow economic rebound and the new financial reform law, we expect the recovery on those fronts to be lower.

However, reflecting the positive investor sentiment, the shares of Fifth Third are trading at a significant premium.
Read the full analyst report on “FITB”
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Read the full analyst report on “MS”
Read the full analyst report on “GS”
Read the full analyst report on “BAC”
Read the full analyst report on “USB”
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