Fifth Third Bancorp.'s stock is likely to be the industry's top performer over the next five years, with shares of First Union Corp. and Fleet Financial Group near the bottom among the nation's largest banking companies, according to Salomon Smith Barney Inc.

The projections are based on return on invested capital rather than on the usual return-on-equity measure. Henry C. Dickson, a Salomon Smith Barney managing director, says return on invested capital better accounts for the costs, risks, and potential gains from mergers and business restructurings than the ROE approach.

He argues that ROE pays too little attention to spent capital, the amount of a bank's capital allocated to merger and restructuring costs. Spent capital represents funds devoted to improving performance and is most often tied to acquisitions, Mr. Dickson says. It would include items such as premiums paid on acquisitions.

Aggressive acquirers generally have higher levels of spent capital than less acquisitive companies. Mr. Dickson figures the amount of capital a bank needs to operate on a daily basis, which he calls operating capital, and adds it to spent capital. He then subtracts the sum from the stock price. That difference shows the market's expectations.

The burden is on the acquirer to demonstrate it can create economic profit with its spent capital.

Mr. Dickson said he believes that the market is efficient and that over time, the higher the expectation, the higher the stock price. He uses Bank of New York and First Union as examples.

When Mr. Dickson tested his formula in May, 66% of the value of First Union's stock represented spent capital and operating capital represented 30%. That meant expectations accounted for only 4%.

In contrast, Bank of New York's spent capital stood at 6% of its stock price, and operating capital, 18%. Expectations represented 76% of Bank of New York's stock price. To Mr. Dickson, that means the value of Bank of New York stock should increase far more rapidly than First Union's.

To us, this means First Union has taken on more execution risk as part of its strategic course, while Bank of New York's risk would seem to be tied to its ability to maintain its focus and its returns.

Stocks are primarily driven by expectations, Mr. Dickson says. For bank stocks to perform well, investors must expect the banks' economic profitability will improve," he said.

It is on this basis that he predicts that stocks of Cincinnati's Fifth Third, Bank of New York and Mineapolis-based TCF Financial Corp. will be the best performers among the banks he follows. He expects the worst performers to include Boston's Fleet and San Francisco-based Unionbancal Corp.

A recently completed study by Solomon Smith Barney found that the level of spent capital among the 48 major banks it tracks soared to $230.5 billion in 1998, from $5.6 billion in 1990.

The banking industry's traditional measures of return have improved strikingly during this decade.

In 1990, when the financial services industry was in the midst of the commercial real estate crisis, the savings-and-loan crisis, and an economic recession, the average ROE was 9.47%. By 1997, it had risen to 17.25%, based on 48 banks tracked by Salomon Smith Barney.

The average fell to 16.49% last year because of the setback created by large mergers and the extraordinary turmoil in world financial markets.

But Mr. Dickson said even last year's ROE figure substantially inflated the performance of some banks. On a return-on-invested-capital basis, the return was only 9.92%.

The difference between the returns on equity and invested capital has been steadily widening, from 0.44 percentage point in 1990, to 6.61 points last year, Mr. Dickson said. Mergers are the big reason.

Last year, the 48-bank universe did not cover its capital costs and sustained an economic loss. But with the recovery in financial markets and slowdown in mergers and acquisitions, economic profitability should improve this year and gain even more next year, Mr. Dickson said.

The best-performing companies should be those that can most dramatically improve economic returns, Mr. Dickson said.

Based on Salomon's study, Fifth Third, whose stock is already among the most highly valued in the banking industry, should tally a 7.68% increase in economic return between 1998 and 2004. Bank of New York, whose 1998 return was by far the largest, at 12.07%, should gain 7.22%, and TCF Financial 7.20%.

Others ranking highly were Mellon Bank Corp., whose projected gain is 6.25%; Firstar Corp 5.3%, from a depressed economic return of minus-4.52% last year; Wells Fargo & Co. 5.29%; and PNC Bank Corp. 5%.

On the other hand, the expected gain by 2004 for First Union Corp., which has disappointed investors this year, is a much smaller 0.98%, well below the median gain of 2.36% for the 48 banks overall, and Fleet could post a return of a negative 0.50%.

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