Banks Try to Balance Conflicting Demands to Pad Lending, Lower Costs

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For better or worse, banking is a balancing act these days.

Bank executives are holding the line on expenses as much as they can while seeking to invest sufficiently in their businesses. Meanwhile, they are trying their best to promote loan growth — on one hand, they are trying to play off the improving economy, but competition remains so fierce that they have to step carefully.

That was the basic message Wednesday from the heads of two of the largest U.S. regional banks, Fifth Third Bancorp's Kevin Kabat and U.S. Bancorp's Richard Davis.

Their loan philosophies differ, as do their spending profiles, but the thrust of their remarks was the same, and they echoed the outlooks of other major banks that have reported quarterly results this month. Investors and analysts are demanding growth and expense controls simultaneously, but the CEOs argued that growth is hard to come by and will require some spending up front.

Fifth Third was especially bearish about lending growth.

"We have and will continue to make deliberate decisions not to add or renew loans at terms or pricing that would produce suboptimal risk return profiles," said Kevin Kabat, the chief executive of the $139 billion-asset company during a conference call on Wednesday.

The company is holding the fort against competitors who are being too loose on rates and loan terms, Kabat said in an interview.

"Where we believe both pricing and structure don't give you a lot of latitude for mistakes, we won't do that business," Kabat said.

Fifth Third's financial performance reflected his stance. Total loans grew 3.6% year over year to $91 billion. That rate is one of the lowest among banks in Fifth Third's peer group, said Marty Mosby, an analyst at Vining Sparks IBG.

The $402 billion-asset U.S. Bancorp has long said it would use the pricing advantage provided by its favorable debt rating to offer highly competitive rates on loans. Still, the company has been adamant that it will not budge on the terms or lengths of the loans.

Richard Davis, the chairman and CEO of U.S. Bancorp, told analysts to expect the company to increase its loans between 6% and 7% in 2015, an upgrade from the 4% to 6% range it has aimed for the last couple of years.

In 2014 the company increased loans about 5.9%, but only 1% in the fourth quarter, the lower end of its guidance.

Andrew Cecere, who was promoted from chief financial officer to chief operating officer on Tuesday, said in an interview that the company's new guidance reflects an improvement to its on-balance-sheet mortgage business and an overall improving economy.

"The shrinking of the refinance business is slowing and leveling off, so it won't be a negative headwind and we are getting good activity in our home equity loans," Cecere said. "And the overall economy is getting a little bit more positive."

Despite raising U.S. Bancorp's loan guidance, Davis cautioned that the bank wouldn't bend to pressure for even more growth.

"We are not going to be dissuaded by people who want to compare us to those who are growing loans faster on a given quarter," Davis said. "I can remember 10 years ago being questioned on a call like this for why our loan growth isn't as fast as someone else's. …We are managing [for a] high-quality loan portfolio."

While they vary in aggressiveness on lending, Fifth Third and U.S. Bancorp appear to be approaching expenses as pragmatically as possible, analysts say. In other words, they are watching every penny but are still investing where they need to.

"Other than requisite spending — technology, compliance, regulation — no one has opened up the piggy bank for special projects," said Scott Siefers, an analyst at Sandler O'Neill, who covers both Fifth Third and U.S. Bancorp.

Fifth Third also outlined its plans for boosting spending in several areas this year, including upgrading technology, including mobile banking; adding EMV chip-and-PIN requirements to its credit card platform; upgrading risk and compliance procedures and systems; and hiring people for its division that provides fee-based services to franchised businesses.

The company disclosed projected costs for some of those items, but not all. Fifth Third expects to spend about $15 million in the second half of this year to add EMV features to credit cards, for example. And upgrading risk and compliance features will likely cost about $25 million for the full year.

"These are things we need and want to invest in," Kabat said in an interview.

While the new items will make it hard to Fifth Third to keep a lid on expenses, it is something the company feels it has to do, Vining Sparks' Mosby said.

"They've had to spend the last five years just trying to be good bankers," Mosby said. "Now they're saying things like, 'We need to increase marketing and not just be prudent bankers.' They can't delay spending on these things too much longer, or they'll be in jeopardy of losing the business momentum they've created."

At $2.8 billion, U.S. Bancorp's expenses were up 4.5% from a year earlier. Cecere said he is expecting the company's core expenses to be relatively flat in the first quarter.

Davis said the company is holding the line on expenses until rates go up, adding that it expects them to rise in the second half of the year.

"So the first half of 2015 … will be a lot like all of 2014 where we will continue to invest where we have to," Davis said. "We will watch discretionary investments and keep them perhaps to further them a bit until we can see a stronger economy."

He added that it would add to "compliance, operating risk areas, audit areas where we think we continue to need to make sure we are at the right level of support." But it would skimp on areas of discretionary spending, such as adding branches or entering a new market. Essentially, the litmus test for capital expenditures of more than $100,000 is if they can produce a return on investment in a year.

If the return is "less than one year it gets approved here every minute. … If it is probably more than three years we are very, very careful and thoughtful about it," Davis said.

That will change when — or if — the operating environment improves, Kathy Ashcraft Rogers, the company's new chief financial officer, said in an interview.

"Once revenues start to grow we can loosen up and will take a different stance on making some of those investments," Rogers said.

U.S. Bancorp reported a 53.2% efficiency ratio, making it one of the leanest banks in the country. Davis said he is surprised that such ratios have not become more common industrywide in the last several years.

"Honestly I don't know why a bank is in the 60% efficiency [range]. It doesn't make sense to me because if you watch every dollar, there's plenty of money that is not necessarily shareholder friendly that has been spent," he said. He added later: "I thought there would be a ton of banks in the low 50%s with us at this point in time. I actually don't know why there isn't."

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