Regional Banks Struggle to Find More Ways to Cut Costs

From legal expenses to branch closures to part-time consultants, regional banks had to keep answering tough questions about spending Thursday.

Four banks — KeyCorp (KEY), Fifth Third Bancorp (FITB), Webster Financial (WBS) and M&T Bank (MTB) — devoted significant portions of their second-quarter earnings presentations to their efforts to trim expenses.

Each institution has its own specific issues with expense control. M&T, for example, is spending tens of millions of dollars to upgrade its compliance functions to gain regulatory approval of its deal to buy Hudson City Bancorp (HCBK).

More broadly, the banks' continued focus on cost cuts shows the industry is still finding it difficult to convince investors of their growth potential. Low interest rates continue to squeeze margins, and mortgage weakness hurts fee income, leaving banks with few options beside cost-cutting.

For some investors, the banks aren't moving fast enough to adjust spending. Mike Mayo, an analyst at CLSA, asked why KeyCorp isn't being more aggressive in its targets for improving its cash efficiency ratio.

The $91.8 billion-asset KeyCorp projected the ratio should improve in the next two to three years, falling from 65.8% in the second quarter to the lower end the 60%-65% range management said. KeyCorp in 2012 embarked on a cost-cutting campaign that included branch closures.

"To tell you the truth, I thought it was a typo at first, and I find that is my sarcastic way of saying I cannot believe your efficiency target is 60% to 65% two to three years out," Mayo said. "That is just abnormally complacent."

(KeyCorp's cash efficiency ratio calculation, unlike some banks' efficiency ratios, excludes the impact of intangible asset amortization.)

Beth Mooney, KeyCorp's chairman and chief executive, answered diplomatically.

"We have talked about it, and we are conscious of the things we need to do to both operate our business, grow our company, as well as continue to become a more efficient and effective company," she said.

KeyCorp's estimates were based on projections for revenue growth and savings from costs cuts without trying to factor in possible increases in interest rates, she said.

Fifth Third executives faced a similar line of questioning.

Ken Usdin, an analyst at Jefferies, wondered why the $133 billion-asset Fifth Third did not lower its projected spending, since it said that its fee income was shrinking.

Tayfun Tuzun, the chief financial officer, responded that Fifth Third could see an improvement in certain fee-income areas, such as payment processing. That could negate the need for expense cuts. Additionally, the Cincinnati company continues to upgrade certain aspects of its business, he said.

"Remember, we are continuing to invest in the company," Tuzun said. "We are not stopping it."

Fifth Third Vice Chairman and CEO Kevin Kabat tried to strike a balance among the competing demands for savings and growth.

"We will maintain our focus on expense management as you would expect from us, while we continue to invest in our infrastructure and business lines," Kabat said.

Litigation has also taken its toll on Fifth Third's spending, and in the second quarter it recorded $61 million in litigation reserve charges. Fifth Third had previously disclosed its legal exposure in March, when it boosted the upper end of its "reasonably possible losses" tied to litigation to as high as $113 million. That was an increase of almost 200% from its previous estimate.

But the $61 million litigation reserve charge in the second-quarter seemed to surprise analysts, who asked Fifth Third to explain it and also say if more was coming.

"Fifth Third is not one of the banks I normally think about having high litigation expense," Ken Zerbe, an analyst at Morgan Stanley, said. "What is driving those expenses and [is there] … any kind of resolution in sight on that?"

Tuzun took a pass at answering either question.

"I am afraid I am not going to be able to give you more detail," he said.

As usual, bankers were asked about to describe the pace of closing branches, as retail banking remains one of the most-common areas for expense control. However, it's not foolproof.

Webster, in Waterbury, Conn., has been a favorite of the investment community for its willingness to aggressively cut branches, especially after it began an ambitious plan to trim and modernize its branch network last year. But the $21.5 billion-asset Webster had a mixed second quarter, demonstrating the difficulty of finding new sources of profits once cost cuts have run their course.

"The number of banking centers is about the right size," CEO Jim Smith said during a conference call. "They may over time be a little bit smaller. They may be better located. They will all be electronically outfitted. [But] the effect of their impact really is probably you are seeing it in the numbers at this point."

Webster is trying to balance branch closures with targeted expansion in new markets. It entered Washington, D.C., during the second quarter with a strategy of adding commercial lenders and no branches, the same tactic it's used in New York and Philadelphia. Webster may eventually have a physical presence in Washington, but doesn't plan a full-scale retail push there, Smith said.

The $90.8 billion-asset M&T Bank got something of a pass on expenses as the Buffalo, N.Y., company continues to upgrade its Bank Secrecy Act compliance functions to obtain regulatory approval for its acquisition of Hudson City.

René Jones, chief financial officer, said the company expects to spend at least $150 million in 2014 on the BSA compliance project, which he described as an "extraordinary amount of money."

"Clearly we are well above a sustainable level [of spending] that you would see on an ongoing basis," Jones said.

M&T projects its spending levels won't return to normal until next year, when it wraps up the project and is able to dismiss some of the professional-services consultants it has hired.

In other words, it wasn't exactly music to the ears of the investment community.

"I don't expect to see any significant improvement in the level of expenses that we are running at in the next quarter or so," Jones said.