Fifth Third’s tough-talking, tightfisted CEO won’t win many popularity contests.
By John R. Engen
July 2001
Institutional Investor Magazine
Fifth Third’s tough-talking, tightfisted CEO won’t win many popularity contests. But George Schaefer boasts numbers that other bankers pine for. Can he keep up the pace as he expands the bank rapidly?
George Schaefer Jr. learned toughness and discipline on the parade grounds at West Point more than three decades ago. Those qualities served him well when he was shipped out to Vietnam, where he won a Bronze Star for valor.
Today, at Fifth Third Bancorp in Cincinnati, Schaefer deploys the same rigor and hardheadedness to attack another kind of enemy: costs and inefficiency. And, as he has done for the past 11 years as the number-crunching, penny-pinching, workaholic CEO of the nation’s 15th-largest bank, he is taking no prisoners.
Schaefer’s weapons of choice bristle on his desk: exhaustive statistical analyses, compiled in thick books that track performance and productivity in each of more than 20 lines of business. One, the “Loan Street Journal,” reveals everything that anybody would ever want to know about Fifth Third’s mortgage department and the production of its 500-plus loan officers. Schaefer leafs through the tome to see who’s on top.
“Everybody’s cheering the guy who’s No. 1, because he’s making us a lot of money. And the guy who’s No. 347, people are saying: ‘Why are we keeping him? Let’s swap him for a first-round draft choice, someone who can move up the list and sell more,’” Schaefer says. “That guy might feel bad, but that’s capitalism. That’s the way we do things here.”
That, literally, is banking by the Schaefer book: a survival-of-the-fittest meritocracy ruled strictly by the numbers. Each of the holding company’s 17 banks, and their 965 branches, sports its own profit and loss statement. Performance statistics are sliced and diced, in many cases down to the individual officer level, and published just like standings and scores in the sports pages. To the leaders go the spoils; a branch manager can win a 30 percent salary bonus for reaching sales and profit goals, plus a personal note of praise from Schaefer. Those near the bottom get notes, too, prodding them to figure out how to improve - or be let go.
By the numbers, Schaefer and his methods have worked wonders; Fifth Third runs rings around just about every other bank in the country, big or small. In a notoriously cyclical industry, Fifth Third has rung up an unequaled 22 consecutive years of double-digit earnings growth. Last year, while such banks as Bank One Corp., First Union Corp. and Fifth Third’s Ohio neighbors KeyCorp and National City Corp. saw their profits decline, Fifth Third increased its net by 29 percent, to $863 million.
Schaefer’s relentless attention to cost-cutting, combined with an aggressive sales culture, pays off in sheer productivity. In the first quarter, as its income jumped by 18 percent to $244 million, the bank earned $20,600 per full-time employee. That was 50 percent better than Bank of America Corp. and 100 percent ahead of Bank One and Wells Fargo & Co., according to SNL Securities in Charlottesville, Virginia. Fifth Third’s efficiency ratio - expenses as a percentage of revenue - comes in at 41; most major banks are above 50.
The list of eye-catching numbers marches on. Fifth Third’s profitability ratios - 2.18 percent return on average assets and 19.6 percent return on shareholders’ equity in the first quarter - rank among the best in the business. At banks above $10 billion in assets, ROAs average 1.15 percent, ROEs 15 percent.
“The returns have been so remarkable, so much better than other banks’, that we view Fifth Third as a strategic corporate asset,” says Michael Abrams, chief equity portfolio manager for insurer Cincinnati Financial Corp., which owns 72 million Fifth Third shares, or 15.4 percent of the total outstanding.
Abrams, who has earned a five-year total return of 343 percent on his investment, isn’t alone in his appreciation. Schaefer, who became CEO in 1990 and has guided the bank from $8 billion in assets to $71 billion, commands a faithful following all over Wall Street as well as the admiration of his peers.
“Everybody at Fifth Third knows what it takes to succeed, and they get handsomely compensated with a stock that continues to appreciate faster than any other stock in the business,” says Anat Bird, a former senior executive at Wells Fargo who is now CEO of California Community Bancshares in Auburn, California.
Regional banks have been out of favor for the past couple of years, in good part because of bungled acquisitions. Not Fifth Third; its shares have been trading recently above $60, for a price-earnings ratio of 35. That was 22 points above the industry average and bettered even companies that have broken away from the banking pack, such as Citigroup (P/E of 20), Bank of New York (25) and Northern Trust Corp. (30).
Along the way, Schaefer has earned a reputation as one tough son of a gun, instilling a gung-ho esprit de corps not far removed from the drill fields. Other bankers have created followings by sheer force of personality, squeezing the most out of their people and their bottom lines. Among the most noted: the Grundhofer brothers of U.S. Bancorp in Minneapolis. Chairman John was once called “Jack the Ripper” for his cost-cutting zeal, while CEO Jerry compiled the only record for cost-efficiency rivaling that of Schaefer as CEO at Firstar Corp. before its February merger with U.S. Bancorp. At Bank of America ex-Marine Hugh McColl Jr. cut a brash figure, the quintessentially brusque, storm-the-beaches CEO who dispensed crystal hand grenades as incentives to his troops.
With McColl’s retirement in April, the 56-year-old Schaefer may now reign as banking’s leading tough guy - and miser. He wouldn’t be caught dead spending the bank’s money on crystal - the bank gives away shoes as tongue-in-cheek sales awards - let alone on a towering headquarters building like the one in Charlotte, North Carolina, known to local wags as the Taj McColl. Schaefer swears off extravagances; he sits in the same teak-paneled corner office, using the same teak desk and credenza as did his two immediate predecessors, dating back to the 1960s.
The attention to thrift and enterprise - and hard work - is evident everywhere, driving productivity. “We argue. It’s full hand-to-hand combat,” says Fifth Third chief financial officer Neal Arnold. “But we’ll decide something and then move on. It isn’t personal. In describing our culture, I call us ‘the dirty uniform crowd,’ because we play for real.”
All the achievements and the accolades reflect past performance. Now Schaefer appears to be tempting the fates. He engineered rapid-fire growth over the past decade through more than 50 small bank and branch purchases. But in November Schaefer negotiated, and in April he closed, Fifth Third’s biggest buy ever, the $5.5 billion purchase of Old Kent Financial Corp. of Grand Rapids, Michigan. In a stroke, assets rose by 50 percent and the employee base by 68 percent. There may be costs and inefficiencies to wring out - Old Kent was weighed down by a 58 percent efficiency ratio. But some analysts have begun to wonder whether Schaefer can replicate his successes on a grander scale. “The concern is that as they get bigger, the culture that has made them successful will be diluted,” says David George, a banking analyst for A.G. Edwards & Sons in St. Louis.
Certainly, the deal has given Fifth Third a new swagger; it jumped three places in the U.S. bank asset ranking, to 15th. More important, it placed Fifth Third among the top six in deposits in Michigan and Illinois, which had been the next states on Schaefer’s horizon.
He is quick to assure listeners that he won’t change his careful, thrifty ways. “It was $2 billion cheaper than if we did it piecemeal,” says Schaefer, who vows not to get caught in the size-at-any-cost trap that snared rivals such as Bank One with its troublesome acquisitions of First USA in 1997 and First Chicago NBD Corp. in 1998. Old Kent, he says, will be immediately accretive, increasing earnings per share by 10 percent in the first year.
Most market observers remain faithful to Schaefer. In June, even after a preannounced $250 million merger-related charge against second-quarter income, Fifth Third’s share price hovered near its 52-week high of $63. Says Cincinnati Financial’s Abrams: “The last thing they want to do is damage their stock price. The P/E is what allows them to gobble up other banks in accretive fashion. And it’s what keeps them independent.”
“Any integration has risks,” adds Lisa Welch, senior research officer for the John Hancock Funds, three of which hold positions in Fifth Third. “They’ve done it well so many times, I have faith they’ll do it right with Old Kent, too.”
A native of West Cincinnati, Schaefer was fiercely competitive from birth. He played tight end on the football team at Elder High School. He went on to West Point, graduating with an engineering degree in 1967, and then to the elite Army Ranger School in Fort Benning, Georgia. After serving in Germany as part of a nuclear demolition munitions unit, he went to Vietnam in 1969. As a captain he was decorated for supervising a 280-man crew that did dangerous duty building a 50-mile stretch of the strategically important north-south highway QL1. He says that he learned important lessons about leadership: “If you take good care of your people, whether they’re soldiers in Vietnam or bankers selling checking accounts in Chicago, then they’ll do a marvelous job for you.”
Back from Vietnam in 1971, Schaefer joined Fifth Third by accident. He was in line for an engineering job at a nuclear plant near Cincinnati, but when its license was delayed, he entered the bank’s management trainee program. He spent most of the next 18 years in commercial lending jobs, but between 1973 and 1977 he worked in the data processing division, rising to head of operations. That division later evolved into the Midwest Payment Systems subsidiary, a consistent and growing contributor to Fifth Third’s earnings (see box, page 44).
After several promotions Schaefer was named president and chief operating officer in 1989. The next year he became CEO, the seventh since the 1908 merger of Fifth National Bank and Third National Bank, from which the quirky name survives.
Schaefer didn’t have to invent a culture of thrift and hard work - it had been instilled by his predecessors. The CEO when Schaefer joined was William Rowe, who ran the bank from 1963 to 1979 on the premise that, in that highly regulated era, says Schaefer, “the only way to make money, if all the deposit and lending rates are set, is by spending less.”
Rowe’s successor, Clement Buenger, CEO from 1979 until 1990, added two precepts: aggressive selling and a more demanding work ethic. Buenger, who had worked in the insurance and supermarket industries, was appalled by traditional bankers’ hours; Schaefer recalls Buenger saying: “Nobody sells here. We’re going to work harder and sell more.” Buenger, who died last year, instituted the “Shoe Leather Award” - a pair of Johnston & Murphy shoes that goes each month to the executive who logs the most sales calls.
When Schaefer took over, Fifth Third was solidly profitable, with operations in Indiana, Kentucky and Ohio. As assets expanded tenfold, Schaefer steadily improved profitability.
How? Heavy reliance on fee-based services and tight control of credit quality. With an assist from Midwest Payment Systems, which processes credit card transactions and operates an extensive ATM network, about 40 percent of Fifth Third’s $2.6 billion in revenues last year came from noninterest sources. On the lending side, the nonperforming-asset ratio - at 0.39 percent of total loans, leases and real estate owned in the first quarter - was roughly half the average for the top 50 U.S. banks.
Schaefer was always eager to grow the bank - though gradually and without sacrificing its frugality. But early on, in 1992, Schaefer stuck his neck out with an unsolicited takeover bid for Cincinnati archrival Star Banc Corp.; he backed away when Star’s board rejected the offer. Today he still maintains that “it would have made sense to have a big local bank in Cincinnati.”
In defeat, Schaefer unwittingly created a monster. In 1993 the underperforming Star hired California banker Jerry Grundhofer to turn it around. Grundhofer soon had Star running as efficiently as Fifth Third, and through a series of acquisitions between 1998 and 2001, it evolved into Firstar and now the $160 billion-in-assets U.S. Bancorp.
“Maybe we learned a bit of humility,” Schaefer says. “Just because we thought it made good economic sense doesn’t mean other boards agree with it.”
Schaefer never wanted to get into an asset-size race, and for an obvious reason: He’d never win. There are limits to how his hard-driving, hands-on style can scale up - limits that he is now testing. As he describes his role: “I just try to get everybody to talk to each other. And when we talk to each other, we make a whole lot of money.”
In assembling the pieces of the current Fifth Third, Schaefer had to do more than just talk. He needed a management structure to accommodate his acquisitions. He settled on a system that cedes much decision-making power to the local level, fashioning essentially a confederation of regional affiliates, each with its own management team and board. But the home office in Cincinnati sets performance targets and provides administrative, marketing and product support. It’s up to the people in the field to do what’s best for their customers and, presumably, for their bottom lines.
Bankers instinctively prefer decentralization - to make decisions close to their customers. But as institutions get bigger, centralization and depersonalization inevitably creep in. Bank One, for example, long resisted centralization by granting autonomy to dozens of local presidents and boards, a system called the “Uncommon Partnership.” By the time of its merger with First Chicago, the partnership had grown unwieldy and was dissolved. That created an opening for banks like Fifth Third that try to meld the advantages of size with a localized marketing formula.
“The strategy is to out-national the locals and out-local the nationals,” says CCB’s Bird, who as a management consultant a decade ago dubbed this approach “supercommunity banking.” She considers Fifth Third “a model of supercommunity banking.”
The prevailing attitude, says CFO Arnold, is a simple one: “Hurry up and do something. We’re not even close to thoughtful. Brilliant thinking doesn’t get you very far in this business. Differentiation comes from execution and a bias for action.”
Fifth Third has been remarkably successful in inculcating this approach in the institutions that it acquires. With their fates riding on the coldly objective accountability system, all employees - including those in support roles - participate in sales blitzes. “Every day I try to sell someone a checking account,” says Diane Dewbrey, senior vice president for data processing operations. “It’s part of what you do here.”
The bank strives to spread the rewards. All 2,500 officers have stock options, and some 9,000 of the 11,700 premerger Fifth Third employees own at least some stock. One of them is Krista Crouch, who puts in 55-hour weeks managing a branch in a Kroger Co. store in Cincinnati’s Hyde Park district. Competing against Fifth Third’s 144 other in-store branches, Crouch offered her nine staff members $25 gift certificates for meeting sales goals. It paid off: Last year she earned a $4,000 bonus and a company-paid trip to Puerto Rico. “The Fifth Third way is very hard for people to understand,” she says. “But you get molded into it over time.”
On the expense side, Fifth Third doesn’t hire consultants or buy naming rights for stadiums. Employees who drive for business, including the boss, use their own cars and are reimbursed 27.5 cents per mile - 5 cents less than the Internal Revenue Service allowance. (They can deduct the difference on their personal tax returns.) When headquarters dispatched videotapes into the field two years ago to explain a complex benefit scheme, some employees complained that it was a waste of profit-sharing money. “I get e-mails all the time saying, ‘Why the hell are we spending money on that?’” Schaefer says.
He will spend money to make money, and that tends to be on basics like checking accounts, which are viewed as an entry point for long-lasting, profitable customer relationships - not to mention a cheap source of funding. Fifth Third boosted checking balances by 7 percent in the 12 months through March, to $28.3 billion. Fees from deposit accounts were $56.2 million in the first quarter, up 18 percent from a year earlier.
Can Fifth Third continue to post such strong results?
One concern is size. But Bird thinks that success in Fifth Third’s niche has more to do with culture than balance sheet. And the bank is still defined by Schaefer’s “firm conviction and vision,” she says. “Size can be an impediment, but it can be overcome if you have a really invested, hands-on, charismatic CEO like George.”
But Schaefer must quickly and seamlessly bring Old Kent into the fold. He got off to a fast start, beginning the integration process months before the deal closed in April; by early June Fifth Third was up and running in Chicago.
Schaefer is supremely confident, he says, because Fifth Third controls just 6 percent of deposits in the states it is focusing on, meaning there is room to grow without a lot of added expense and without having to do another acquisition.
He admits, however, that there were solid reasons not to buy Old Kent. “We said, ‘We’ve already got tremendous earnings, and this is twice the size of any deal we’ve ever done.’” But he and his brain trust concluded that the price was a bargain at 14 times earnings and that they could gain from one transaction what might otherwise take four or five.
And he’s got a strong ally in David Wagner, the Old Kent CEO who has stayed on as head of the Michigan operation. Wagner approached Schaefer last year to discuss a sale, though not, he says, out of desperation. Old Kent had increased its earnings and dividends for 42 straight years. Wagner had grown concerned, however, about slowing revenue growth, and he felt he needed Fifth Third’s selling and efficiency skills to keep the earnings record alive. “You’re going to have to be the low-cost producer. And you’re going to need more sources of revenue beyond the balance sheet,” namely fees, Wagner asserts.
At Fifth Third, he says, “the key seems to be keeping the system simple, fair and workable, and staying focused on results. Fifth Third’s trick has been to stay focused on the things that really matter.”
Further afield, there is the delicate question of delegation. Holding the titles of president and CEO, Schaefer hasn’t bothered to anoint a successor. That might not normally be a concern, but Schaefer has had two heart bypass operations, leading some analysts to worry that he will spread himself too thin. Schaefer dismisses such talk, saying that he had his first surgery in 1982, at age 36, and that the second operation in 1997 was routine. “The arteries feel pretty good,” he says.
The closest Schaefer has to a No. 2 is Arnold, 41, who joined the bank’s investor relations department in 1990 and has been CFO since 1997. But the next leader could just as likely come from the banking front lines: perhaps Robert King Jr., 45, president of the Fifth Third affiliates in Cleveland and Toledo; Robert Niehaus, 54, who oversees the flagship bank in Cincinnati; or commercial lending chief Stephen Schrantz, 52. Wagner, 47, could also be in the mix - if he delivers.
Schaefer says “they are all good names” but offers no clue about who might be at the head of the line. Ever the competitor, he doesn’t seem eager to step aside anytime soon.
“This game is about sales and execution,” Schaefer adds. “As long as we continue to do those things, we’ll win.”
Postmerger integration strategies don’t get much simpler.
Flexing the tech muscles
The processing of credit and debit card transactions is one of those mundane backroom tasks that nobody thinks much about unless something goes wrong - and that many banks therefore prefer to leave to others. Fifth Third Bancorp is one of those others, and it has spun plastic payments into gold.
From humble beginnings as an in-house data processing department, Fifth Third’s Midwest Payment Systems subsidiary has emerged as a leader in handling point-of-sale and ATM payments for major retailers and smaller banks. In 2000 MPS processed 4.8 billion transactions for more than 25,000 clients, enough to rank in the transaction-processing top ten with such nonbanking powerhouses as First Data Corp. and Concord EFS and with operations owned by banks larger than Fifth Third: Bank of America Corp., National City Corp. and U.S. Bancorp.
“It’s a powerful growth business. Not many banks have it,” says banking industry analyst Fred Cummings of McDonald Investments, a unit of KeyCorp in Cleveland.
Nor do many banks enjoy a price-earnings multiple above 30, as Fifth Third does. MPS is a factor in that, but it’s hard to be sure how much of one.
Last year MPS’s revenues grew by 34 percent, to $242 million. Cummings projects $300 million this year and sees 30 percent annual growth rates, corresponding to general transaction industry trends, continuing indefinitely. But because MPS contributes just 7 percent of its parent’s total revenues and 10 percent of earnings, Cummings concludes that Fifth Third’s stellar banking performance has much more to do with its P/E than does MPS.
A.G. Edwards & Sons analyst David George notes that Synovus Financial Corp. of Columbus, Georgia, has a 30-plus P/E, in part because it owns 81 percent of Total System Services, which processes 200 million MasterCard and Visa accounts for banks in 21 countries. Synovus has only $15 billion in assets, compared with Fifth Third’s $71 billion, but Total System accounted for 43 percent of Synovus’ $1.4 billion in 2000 revenue and 33 percent of its $263 million in net income.
Total’s public shares were trading recently at 64 times earnings, and George says MPS could approach that if it stood on its own.
But Fifth Third has “not given much serious thought” to a spin-off, says Barry Boerstler, the executive vice president in charge of MPS. MPS and the banking operations share technology platforms and costs. “Being part of the bank is good. There are a lot of cross-sell tie-ins with the affiliates. If you’re off on your own, you don’t get as much of that,” adds Boerstler.
Though MPS lacks its own deal-making currency, Fifth Third can fund acquisitions, such as a 49 percent stake taken in February in Universal Cos. of Milwaukee, a card processor that complements MPS’s big-merchant strategy by catering to smaller stores. The deal, for an undisclosed price, included an option to buy the remaining 51 percent.
MPS has made its mark servicing card-accepting retailers such as Circuit City Stores, Kroger Co. and Nordstrom. Its ATM operations include Jeanie, a regional network with 1,900 machines, as well as a system serving U.S. military bases around the world.
When Abercrombie & Fitch Co. recently awarded MPS a three-year credit card processing contract, MPS came in on the low end of bids ranging between 1 and 6 cents per transaction, says Richard Marinzel, treasury manager for the specialty retailer. He likes MPS features such as Mvision, which lets clients retrieve real-time transaction information via an Internet browser. Columbus, Ohio-based Abercrombie banks with Fifth Third, but the real clincher was other retailers’ word-of-mouth.
“I heard nothing but raves about them at industry conferences,” Marinzel asserts. “Those testimonials are better than any proposal.”
Like other Fifth Third managers, Boerstler is held accountable by his own profit and loss statement. He feels the companywide pressure to keep costs down, but revenue growth is also a priority. So he doesn’t skimp on cutting-edge features like Mvision. “We won’t be penny-wise and pound-foolish,” he says.
