SunTrust's Need to Defend Spending Shows Investor Focus on Costs

It's funny how one little bump in the road can send bank executives scrambling to defend themselves and their strategic plans.

When SunTrust Banks (STI) reported first-quarter results on Monday, the Atlanta company highlighted its 16% year-over-year rise in earnings. It touted growth in commercial lending and in fee-based businesses like wealth management.

Yet what analysts focused on was a rise in expenses. In the low interest-rate environment, cost-cutting is one of the few sure-fire ways to generate more revenue.

Some institutions this quarter, from Hancock Holding (HBHC) to Comerica (CMA), have reported higher profits through declines in operating costs. But more of their regional peers — including Huntington Bancshares (HBAN), Fifth Third Bancorp (FITB) and BB&T (BBT) — said efficiency ratios worsened in the first quarter compared with a year earlier.

The $180 billion-asset SunTrust's chairman and chief executive, Bill Rogers, and its chief financial officer, Aleem Gillani, have for months talked about cutting costs, by eliminating jobs, closing branches and more. The ultimate goal is to lower its efficiency ratio below 64% this year, and 60% in the long term; the figure has gradually moved in that direction since hitting 71% at the end of 2012. The efficiency ratio measures noninterest expenses as a percentage of the combination of net interest income and fee income; the lower the figure, the more efficient the bank is considered.

But SunTrust's efficiency ratio rose 286 basis points to 66.83%, compared with a year earlier. Naturally, Rogers and Gillani were peppered with questions and forced to explain the situation.

"If I look at year-over-year year trends it doesn't look so good," Mike Mayo, an analyst at CLSA, said during a Monday morning conference call. "What gives you confidence that you will meet your efficiency target … this year?"

Gillani responded that SunTrust has "been very focused on expense management" and that "trying to extrapolate out of a single quarter or even a single year may not give you a really good indication" of the company's progress.

"We are a good size company," Gillani said. "This is a complex business."

Rogers backed up Gillani by saying, "this quarter's efficiency ratio is ahead of where we thought we would be internally on our path to 64%."

Marty Mosby, an analyst at Guggenheim Securities, came to Gillani's and Rogers' rescue. Mosby pointed out that, in the first quarter of 2013, SunTrust had booked a $41 million incentive accrual reversal. SunTrust did not adjust its first-quarter efficiency ratio to reflect that reversal. If it had, then SunTrust's first quarter 2014 efficiency ratio actually would have improved from the prior-year period.

"Marty, you are 100% correct," Rogers said. "Thank you."

In a follow-up interview, Mosby explained that SunTrust last year decided to stop making certain payments to an executive-compensation program, likely a long-term incentive plan.

"That's an unusual item," Mosby said in the interview. "You're not going to reverse incentives on an ongoing basis. It made the figure look better a year ago than it should have."

More broadly, SunTrust continues to make steady improvement toward improving its efficiency ratio, Mosby said in the interview.

"Their mortgage banking expenses came down significantly," Mosby said. "Credit expenses came down to where they're much lower."

SunTrust still wants to lower its efficiency ratio below 60%, a figure that will be much tougher to achieve, largely because of broader economic forces, Rogers said.

"We are not backing off our guidance in getting to a below 60% efficiency ratio," Rogers said. "We have got the right plans in place and infrastructure and management focus and business and environment that we can get there. But the length of time of when we get there is going to be economic dependent and somewhat interest rate dependent."

SunTrust has not set a specific date for when it wants the ratio to fall below the 60% mark, Rogers said.

Hancock Holding, in Gulfport, Miss., cut costs just a few months after catching heat from Wall Street for not being aggressive enough with expenses.

Carl Chaney, the $19 billion-asset company's co-CEO, touted its 62% efficiency ratio in the first quarter as being three quarters ahead of schedule. The company ultimately is aiming for a ratio of 59% or lower.

The company cut costs by closing branches, reorganizing market leadership and negotiating procurement contracts, among other things.

The company also consolidated its two banks. Hancock continues to look at ways to cut costs; last week it said it would close 16 branches in Mississippi, Florida and Louisiana during the third quarter.

However, Hancock executives warned that they will need to boost revenue to meet their targest efficiency ratio, while noting that sometimes growth requires spending money. For example, it recently opened a new regional headquarters in Lafayette, La., to tap into the market's oil and gas business.

"We are not done," Chaney said during a conference call last week to discuss quarterly results. "With expenses in line, we will need to generate additional revenue in order to meet our goal. That means that over the next couple of quarters, you may see expenses rise slightly as we reinvest in higher return revenue-generating lines of business."

Paul Davis contributed to this article