Years of branch closures and job cuts are paying off for banks in the form of much-improved efficiency ratios.
Even with persistently low interest rates crimping overall profits, the industry's average efficiency ratio fell to 57.95% in the second quarter, the lowest level since the first quarter of 2010, according to BankRegData.com, which collects data from Federal Deposit Insurance Corp. call reports. That's down from 59.75% in last year's second quarter and a peak of 66.52% in the fourth quarter of 2011.
Omit thousands of small community banks — which tend to be less efficient than their larger peers — and the numbers are even more impressive. For all banks with at least $1 billion of assets, the average fell to 56.8% at June 30, down from 58.3% a year earlier, according to Moody's Investors Service.
Absent opportunities to meaningfully improve profitability ratios like return on assets, return on equity and net interest margin, many banks have made lowering the efficiency ratio — a key measure of expense management — a top priority in recent years. They have done so by reducing headcount, consolidating or shrinking branches and renegotiating vendor contracts. Efforts to shrink efficiency ratios have also been aided by reduced legal costs as probes tied to the financial crisis wind down.
Still, some bankers wonder if efficiency ratios can go much lower. Many banks have already shed as many jobs and branches as they plan to and likely won't see much improvement in efficiency until the economy improves, interest rates rise and profits go up, they said.
A rate hike could even hurt efficiency ratios in the short term because, to stay competitive, banks would likely have to raise rates on deposits before they would start generating higher yields on loans.
"If net interest income is hurt by a rise in funding costs and banks don't get [an immediate] corresponding boost in yields, that would be captured in higher efficiency ratios," said Allen Tischler, a Moody's senior vice president.
Other banks, meanwhile, have been slow to close branches because they fear missing out on fee income, said Tom Broughton, the chief executive of the $5.6 billion-asset ServisFirst Bancshares in Birmingham, Ala. Most consumers still open accounts at branches, and many banks rely on the accompanying fees — particularly overdraft fees — to drive profits, he said.
"Retail branch profit is predicated on NSF [nonsufficient-funds fees] revenues," Broughton said in an interview. "Branches are a perceived need, rather than an actual need in the customer's mind."
The efficiency ratio is calculated by dividing noninterest expense, minus amortization of core deposit intangibles, by the sum of net interest income and noninterest income. Tischler said that what's most impressive about the industry's overall improvement is that it has come at a time when all banks are spending significant sums on compliance and cybersecurity.
The $195 billion-asset SunTrust Banks was able to reduce its efficiency ratio to 60.6% in the second quarter by lowering headcount, reducing corporate travel and renegotiating leases. While the figure is still short of the Atlanta company's ultimate goal of a sub-60% ratio, it still represents significant improvement from just a year earlier, when its efficiency ratio was at nearly 64%.
At an investor conference on Monday hosted by Barclays, SunTrust's chief financial officer, Aleem Gillani, reiterated the company's ultimate goal of improving its efficiency ratio to below 60%. SunTrust likely will not hit the target this year and Gillani did not provide an estimated date for doing so, but he said its full-year efficiency ratio for this year than its 2015 full-year ratio of 62.6%.
Even banks that already had rock-bottom efficiency ratios have posted improvements. The $9.6 billion-asset Centennial Bank in Conway, Ark., reported a 37.52% efficiency ratio in the second quarter, a 287-basis-point improvement from a year earlier, according to its 10-Q report. That's close to Centennial's 35% target, Chairman Johnny Allison said in a July 21 conference call.
Centennial has a low expense base through cost-cutting and an ongoing review of outside vendor contracts, said Donna Townsell, vice president of corporate efficiency at Centennial's holding company, Home BancShares.
"We just renegotiated our Arkansas janitorial contract and we expect a meaningful savings from that line item," Townsell said during the July 21 call.
ServisFirst has posted an efficiency ratio lower than the industry average through outsourcing and by maintaining a small branch network, Broughton said. Its second-quarter ratio was 38.01%, down 223 basis points from a year ago, according to its FDIC call report. ServisFirst has 22 branches and it employs 408 full-time workers.
ServisFirst has deployed more than a thousand remote deposit capture machines to its customers, which helps maintain a low staff count at branches, Broughton said.
"I've found if you have a ground floor office in a Nashville officer tower and you have a customer on the fifth floor, they won't even come downstairs to make the deposit," and instead will submit the deposit via remote capture, he said.
Even as banks have improved efficiency, investors continue to press them to find ways to trim expenses. Yet there is a feeling among some bankers that, no matter how much they cut costs, it still won't be enough to satisfy investors and analysts.
"If we did nothing today with our expenses, and the economy got better and margins got better, our efficiency ratio would go down," Kelly King, chairman and CEO of the $217 billion-asset BB&T, said during a July 21 conference call. "You wouldn't give us any credit for that, but that's what would happen."
"Conversely, if you have a period where revenues go down, maybe you're doing a great job on expenses, then your efficiency rate goes up," King said. "You would blame us for that. I think that efficiency ratio is taken out of context."
BB&T's second-quarter efficiency ratio of 64.79% was 603 basis points lower than a year earlier, according to its call report. But it was 684 basis points higher than the industry average.