You could almost imagine Richard Davis having to grit his teeth over the phone — and he wasn't the only chief executive who had reason to do so Thursday.
Yes, his U.S. Bancorp churned out 3.1% more revenue in the third quarter compared with a year earlier, a number that several of his megabank rivals would envy. However, expenses increased twice as much.
Historically, Davis has prided himself on U.S. Bancorp's positive operating leverage, meaning that its revenue growth has outpaced its expense growth. But the low-interest-rate environment has made it difficult, perhaps nearly impossible, to achieve.
He still cares about operating leverage, he assured analysts on the company's quarterly conference call, but he acknowledged that he cares about it less now. The company is aiming for revenue to outpace expenses in 2016, but that is reliant on rates increasing somewhat.
Other regional banks — including KeyCorp, First Republic Bank and BB&T — reported revenue gains and higher noninterest expenses in the third-quarter, too, and their CEOs fielded many questions about their spending habits, plans to control them, the vulnerability of their business models and many more tough questions. Here's a rundown of they had to say.
KeyCorp: Hiring Talent
Executives at KeyCorp in Cleveland are taking the approach that you have to spend money to make money.
The $95.4 billion-asset company posted a 7% increase in revenue from a year earlier and attributed this to investments it has made, like the acquisition last year of Pacific Crest Securities, a technology-focused investment bank.
KeyCorp has also hired more than 60 senior bankers to help bolster its lending. Its loan portfolio increased roughly 6%, to $59.3 billion, from a year earlier, as its commercial and industrial loans rose almost 15%. Roughly 80% of the $3 billion of loan growth in the corporate bank came from the more than 580 new clients it added, said Christopher Gorman, president of KeyCorp's corporate bank.
Still, there seemed to be some skepticism among analysts listening to the earnings call. One questioned whether Ohio rivals such as Huntington Bancshares in Columbus or Fifth Third Bancorp in Cincinnati could simply go out and replicate KeyCorp's model and neutralize the benefits of its hiring spree.
KeyCorp's corporate bank provides its loan officers services that make it more appealing to work there, executives answered. The company focuses on seven sectors with 46 research analysts covering 777 companies, Gorman said. This allows its bankers to provide industry experts to clients as opposed to competing solely on price or credits terms, he and others said.
Because of this, replicating KeyCorp's model is "not just as easy as hiring a few bankers because you need the product experts and you need the industry experts," Gorman said.
Because of KeyCorp's different business lines, it also has different options for working with clients, Chairman and CEO Beth Mooney said. For example, the company can either generate revenue by making a loan to a corporate client or by helping that client with a debt placement. Roughly 44% of its revenue comes from fee income.
"It's really a very holistic approach and loans are a significant part," Mooney said. "But also it is indicative of the broader model we are able to bring."
KeyCorp has long faced criticism over expense control. Noninterest expenses rose more than 2%, to $724 million, mostly from additional personnel expenses tied to the new hires, the acquisition of Pacific Crest and performance-based compensation, the company said.
The company's efficiency ratio has held around 65% for the last few quarters because of the investments the company has made, like its new senior bankers, have not fully matured yet, said Chief Financial Officer Don Kimble.
"We still think over the next couple of years we can drive that efficiency ratio from the 65% level down into the lower 60s," Kimble said. "But I think what you're going to need to see is more maturity of some of the investments we're making and have that translate to improvements in the overall efficiency going forward."
First Republic: Paying to Diversify
Sometimes you have to spend money to respond to competitive threats and regulatory demands.
The $55.4 billion-asset First Republic in San Francisco reported strong revenue growth in the quarter despite facing increased competition in its bread-and-butter business of jumbo mortgage lending.
Single-family originations fell 17% year over year, to under $1.9 billion, yet core revenues climbed nearly 15% for quarter, to $459 million, as the $55.4 billion-asset bank boosted its commercial, construction and home-equity lending and continued to attract wealth management assets.
In a conference call Thursday, CEO James Herbert said that the largest banks in particular are reducing rates and, to a degree, relaxing underwriting standards to win more jumbo business. First Republic has long been willing to budge on price — particularly for clients that use the bank's other products and services — but will concede the business if it means increasing loan-to-value ratios or amending other terms.
"We are not following" the large banks, Herbert told analysts. "We will compete on price, we will not compete on" terms.
On Thursday's conference call, Herbert took a number of questions about expenses, which increased by nearly 16% year over, to $275.9 million.
The bank's expenses have been rising steadily over the last two years as it brought in consultants and invested in new systems in preparation for the increased regulatory scrutiny that comes with crossing the $50 billion-asset threshold.
Herbert told analysts that regulatory-related costs are close to "topping out," but that they should not expect to see a meaningful decline in such expenses anytime soon now that it has surpassed the $50 billion mark. As a larger institution, Herbert said that First Republic will be spending roughly $5 million a year on regulatory exercises such as drafting so-called "living wills" and preparing for more stringent stress tests.
Company officials also said that First Republic is seeing a significant payoff from its heavy investment in business development. Though salary and compensation costs have increased more than 21% year over year, those costs have been more than offset by growth in loans, deposits and wealth assets under management, all of which increased by double digits.
Wealth assets are expected to rise even more substantially this quarter following the Oct. 1 acquisition of Constellation Advisors. That deal is expected to add roughly $6 billion of assets under management to the $58.8 billion it reported at Sept. 30.
BB&T: Patient M&A
BB&T's higher cost structure is largely a function of its focus on acquisitions.
The $209 billion-asset company's noninterest expense rose 4% in the third quarter from a year earlier, to $1.6 billion. But $77 million — or 5% of the quarterly expenses — were tied to acquisitions, notably the purchases of Bank of Kentucky Financial and Susquehanna Bancshares. Management said during a conference call Thursday that Winston-Salem, N.C.-based BB&T will likely incur another $60 million to $80 million in merger-related charges this quarter.
Other expense items rose as a result of acquisitions. Personnel expense increased 11% from a year earlier, as BB&T added roughly 2,100 employees, while occupancy costs rose by 8%. BB&T, however, has already disclosed plans for branch closings and initial job cuts.
Profit decreased 4% from a year earlier, to $492 million.
The long-term goal, however, is to "rationalize the expense bases" at the acquired companies, Kelly King, BB&T's chairman and CEO, said during the conference call. "This is an important part of our expense strategy and it gives us a real lever that would not be available if we were not in the acquisition business," he said.
Revenue, meanwhile, is expected to keep rising as a result of recently completed deals, along with the pending purchase of National Penn Bancshares. Susquehanna, for instance, added $150 million in revenue during the two months it was a part of BB&T in the third quarter. (Overall revenue increased by $155 million compared to a year earlier.)
"We're very excited about having these new assets, and we think they will be really productive for us as we go forward," King said.
Overall noninterest expense, absent merger costs, fell "slightly," Daryl Bible, BB&T's chief financial officer, said, adding that the workforce "remained relatively flat" once employees at acquired institutions were excluded.
Other efforts could help BB&T lower long-term costs, including its new U platform that debuted last month. The in-house application lets customers set the color schemes, profile pictures and features they can access after logging in. Such initiatives don't "take a huge amount of actual capital," said Ricky Brown, the company's president of community banking.
"Clearly our most expensive channel is the branch, which we'll be rationalizing over time," Brown added. "With the advent of digital and things like U … we will be able to go into markets where we've got great distribution, great coverage and great brand and perhaps be able to take branches out."
U.S. Bancorp: Picking Its Spots
But the pressure on bank executives to take quick cost-control measures remains intense
U.S. Bancorp is tightening its belt at least another notch. It has already frozen its headcount for about a year. In the third quarter, it sought to upgrade talent by essentially replacing underperforming employees. That effort pushed expenses to rise but ultimately should improve efficiency, CFO Kathy Rogers said in an interview.
Additionally, the company said it is expanding its efficiency program to focus on discretionary spending. Travel is being replaced with video and teleconferencing when possible. When travel is needed, the company is looking for airfare and hotel discounts.
"We are doing these things with the intent to return to positive operating leverage, but they may also allow us to use those savings to reinvest in other opportunities," Rogers said.
Of course, there are areas where the company is not looking to cut: technology, namely mobile technology, and compliance.
"I haven't starved [mobile technology] one bit because that is the changing environment we are in," Davis said.
And that is the kind of balancing act facing all the CEOs.