A Regional Bank Ripe for the Picking

For years, regional banks have been seen as powerhouse performers, and Fifth Third Bank of Cincinnati was once the leader of the pack. Its earnings far outpaced the industry and its strong stock price allowed it to snap up weaker peers.

Now, regulatory troubles and disappointing deposit growth have reversed its fortunes and its sagging stock price, down 43 percent since its high in March 2002, has made the company a takeover target itself.

One analyst has called Fifth Third the "most attractive acquisition candidate in the banking industry." A report last week suggested that U.S. Bancorp and Wells Fargo might already be licking their chops.

Fifth Third executives dismiss a potential sale as rumor. "We are really focused at growing the businesses that we have," said George A. Schaefer Jr., the bank's chief executive for the last 16 years.

Still, there is no question that management is concerned about the bank's current performance, and Mr. Schaefer, an Army Ranger during the Vietnam War, is aggressively trying to get the company back on track. Fifth Third is focused on improving service, reining in expenses and expanding its 1,100 branches deeper in places like Pittsburgh and St. Louis as well as faster-growing markets like Chicago and South Florida. But is time running out?

"This is a very different company than what it was a couple of years ago," said Richard X. Bove, the banking analyst with Punk, Ziegel, who says the bank is takeover bait. "It is still competing on price, but is attempting to add service. It doesn't have the cost advantage that it once had. And it has made the fundamental decision to move into growth markets as opposed to its traditional approach to gain market share in existing markets."

Fifth Third, the nation's 11th-largest bank, had earned Wall Street's respect with 15 percent earnings growth rates for years. With a strong share price, it attracted talented managers with stock options instead of large salaries and passed part of the cost savings to customers through better prices on deposits and loans. Throughout the 1990's, it expanded rapidly, growing from a bank with $8 billion in assets in 1990 to almost $105 billion in 2005.

What it did not do, however, was invest heavily in its back-office systems and internal controls. Those decisions came back to haunt Fifth Third in September 2002, when it took a $54 million charge after improperly accounting for some mortgage-backed security investments.

Two months later, the Securities and Exchange Commission stepped in to scrutinize the books. Federal and state banking regulators halted all acquisitions and branch openings while they conducted similar reviews.

The regulatory actions forced the bank to improve its accounting procedures, triple its audit staff and reshuffle its executive ranks. Of its 14 top officers in 2002, only half remain at Fifth Third and the bank has gone through two chief financial officers in two years.

"We were really too comfortable with the way we had done business," said Neal E. Arnold, an executive vice president who was chief financial officer during the regulatory review. "It's never fun to sit down and look at your organization and decide that you need to upgrade some positions."

The acquisition ban was lifted in the spring of 2003 and the company was able to build its own branches a little sooner. Still, it was a costly distraction that allowed other competitors, like KeyCorp and National City, to gain ground.

"The worst of the deterioration is probably over," said Denis Laplante, a banking analyst with Keefe, Bruyette & Woods in New York. "We are within a couple of quarters of seeing a turnaround."

Fifth Third has remained committed to its decentralized management strategy, which it contends allows for faster and more flexible decision in local markets. Each of its 19 regions has its own independent president and board. But the bank recently retooled its retail strategy as customer deposit levels have slowed. Among the problems, executives concede, was that its pricing strategy was wrong.

Over the last few years, branch managers hoped to bring in new customers by offering temporary teaser rates that were often more than three times what competitors next door were paying. But when the promotional rates went away after a few months, their customers did, too.

"The rates got so out of whack that after the teaser rate went away, the customer felt they didn't have a good value," said Kevin T. Kabat, who heads Fifth Third's retail unit. This summer, Fifth Third overhauled its deposit strategy to focus on building stronger customer relationships with lower and steadier rates. It also began closely tracking the daily and weekly sales of its staff.

Still, the bank's management faces considerable headwinds as it tries a major turnaround. Across the industry, higher interest rates and tougher competition are starting to squeeze profit margins. The deposit inflow and home mortgage booms of recent years are expected to slow. And a big portion of Fifth Third's branches are in Ohio and Michigan, where the American automobile industry is most concentrated. That makes it particularly vulnerable to an economic decline.

Mr. Schaefer remains undeterred and says the mix of businesses and locations will allow the bank to brave any economic storm. "The auto industry is a big concern," he acknowledged. "But if you look here, Cincinnati is the headquarters of the Japanese auto industry, and they are booming."

Besides, as Mr. Arnold put it: the regulatory actions led the company to hasten the pace of change. "We often say around here, 'We haven't seen the Celtics in the N.B.A. championships,' " he said. "You have got to reassess."

What are people saying about mortgages today:

Rates on 30-year mortgages edged down last week to a seven-month low. Mortgage-giant Freddie Mac reported Thursday that 30-year, fixed-rate mortgages fell to 6.3 percent, down slightly from 6.31 percent two weeks ago. It put rates at the lowest level since they were at 6.24 percent the first week of March.

Bank of Hawaii, Central Pacific Bank, Territorial Savings Bank and Wells Fargo Home Mortgages all cut their 30-year mortgage rates to 5.75 percent this week.

Most people think of a mortgage as a means to an end. After all, you buy a house, not a home loan. But a mortgage is much more than the path to homeownership. It is a financial instrument that must be managed, just like any other financial investment.