Banks to Keep Cutting Until Signs of Recovery Add Up

Banks are counting on a spring revival to spare them from another long year.

Commercial borrowing hit a wall in the first quarter after steady improvement last year. Meanwhile, mortgage lending, the industry's cash cow of the last couple of years, slowed down considerably.

That one-two punch forced executives to slash expenses and loan-loss provisions to meet earnings targets. How long they can keep it up until revenues improve is unclear.

Some bankers are optimistic about an increase in lending in the second quarter, but that might not be enough for them to overcome low rates, the mild economic recovery and intense competition.

"They may well gain traction this quarter, but that is the glass-half-full side of the equation," says Jeff K. Davis, managing director of the financial institutions group at Mercer Capital. "They are making more loans at lower yields… [and] they are breaking a heavy sweat to hold earnings in place."

Kelly King, the chief executive of BB&T (BBT), told analysts that commercial-and-industrial loans as well as commercial real loans look promising.

"Momentum really started picking up in March, [and] it seems to be kind of continuing as we head into April," King said in a conference call on Thursday. "People feel better in the spring and a little detail on that: our C&I, CRE and consumer pipelines are improving."

Richard Davis, the CEO of U.S. Bancorp (USB), made similar remarks about an improving lending environment earlier in the week; Stephen Steinour, CEO of Huntington Bancshares, did, too.

"January was a disappointing month; February, got a bit better; March…much closer to normal," Steinour said during Huntington's conference call Wednesday. "As we come into the second quarter, we're sitting with a strong pipeline in commercial."

The situation was different in the first quarter, when many banks had to take an ax to expenses to make up for lost revenue.

KeyCorp (KEY), reported that it has identified $105 million of the $200 million in expense savings it plans to have by next year. It decreased its noninterest expense by 7% from the end of 2012, to $681 million. However, KeyCorp warned that expenses would rise in the second quarter as it spends money to close branches.

SunTrust's noninterest income fell 12% from a year earlier and 10% from the fourth quarter, to $1.36 billion, reaching the lowest level at the Atlanta company in three years.

The company pointed to changes in customer trends, as well as its own response to those changes, for the improved efficiency. "Clients are increasingly using our self-service channels," William Rogers Jr., SunTrust's chairman and CEO, said during a conference call to discuss quarterly financial results Friday. ATM deposits have tripled and usage of mobile applications has quadrupled in the past two years, he said.

"That has given us the opportunity to make some changes to our staffing model and, more recently, our retail branch network," Rogers said.

Despite King's optimism about loan growth at BB&T, the Winston-Salem, N.C., company is examining spending and plans to close some branches.

"Expenses are a major focus for our company this year. We recognize this is a slow economy," King said in his conference call. "We think, frankly, the economy will be fairly slow for the rest of this year, maybe the next two or three years so we have to adjust our business strategies accordingly."

BB&T reported expenses of $1.4 billion, down 5% from the end of the fourth quarter. However, its efficiency ratio of 56.4 was weaker than in the previous quarter or year over year.

PNC Financial Services Group (PNC), BB&T, KeyCorp, SunTrust and several other large banks cut expenses more aggressively than analysts expected in the quarter. Fifth Third Bancorp (FITB) also cut expenses, but differentiated itself by not doing so in a bid to cushion a blow from revenue.

"Importantly, there was no significant miss on revenues, which has become a regional bank theme this [quarter]," R. Scott Siefers, an analyst with Sandler O'Neill, said in a research note about Fifth Third on Thursday. "The company beat our forecast on the provision and expenses."

The largest banks are also minding their spending.

Citigroup (NYSE:C) Chief Executive Officer Michael Corbat in December announced a wave of cost cuts, including laying off 11,000 staff and closing 84 branches. Executives from Citi said Monday further cuts are possible but would likely be more incremental.

Larger rival JPMorgan Chase (JPM) has also been cutting back; in February it announced plans to eliminate some 17,000 jobs by the end of next yearby paring down its mortgage operations and shrinking its consumer bank staffing levels through attrition.

The long-term benefit of all the cost-cutting is that if and when the economy improves, many banks will be set for a tremendous windfall, Jeff Davis says. 

"They are generating incredible operating leverage possibilities," he says.

Until then, there will be more pressure for banks to pursue mergers and acquisitions to deliver growth to investors. However, Jeff Davis is skeptical that larger institutions will pursue deals because regulators oppose the big banks getting any bigger.

"It should lead to more M&A, but I don't know if it will," he says.

That leaves expenses playing a game of limbo: how low can you go?

"The industry is going to find out it can get by with a lot fewer people than it ever thought it could," Jeff Davis says. "That will be forced as management teams work really hard to do whatever they can to hold current earnings. Expense-cutting is all they can do. The credit lever is almost done, and mortgage is fading."