U.S. Bancorp (NYSE:USB) has long been one of the most efficient big banks in the United States. But the Minneapolis-based bank doesn't approach efficiency in the same way that most of its competitors do. As opposed to focusing on expenses, U.S. Bancorp has minimized its efficiency ratio by driving revenue.
Listen to the following segment of Industry Focus: Financials as The Motley Fool's Gaby Lapera and John Maxfield discuss why this is such an important insight and how it's propelled U.S. Bancorp to the pinnacle of the bank industry.
A full transcript follows the video.
This video was recorded on March 27, 2017.
Gaby Lapera: Let's talk about efficiency ratios. What is an efficiency ratio? Very easy question for you.
John Maxfield: Efficiency ratio, this just measures the percentage of revenue that a bank spends on operating expenses.
Lapera: Yes. So, the lower the efficiency ratio, the better. Most banks shoot for an efficiency ratio of around 60%. Drumroll. I don't think you can hear that. [laughs]
Maxfield: It's a very quiet drum. [laughs]
Lapera: What is U.S. Bancorp's efficiency ratio?
Maxfield: U.S. Bancorp's efficiency ratio last year, its GAAP efficiency ratio, which is just taking your non-interest expenses, so, your operating expenses divided by net revenue, was 55%.
Lapera: That's really good, for people who don't know. Amongst the other top big banks, you have Bank of America sitting at 66%, Wells Fargo and [Citigroup] both around 59%, [JPMorgan Chase] around 58%, and those are the big banks. In general, they operate pretty well. Below the eighth-largest bank, most banks' efficiency ratios are pretty above 60%. There is an exception. I think New York Community Bancorp might be the country's 25th biggest bank, but it's doing this thing where it's been sitting around $48.9 billion in assets so it doesn't trip the regulatory threshold for having more regulations put on it. And its efficiency ratio is abnormally low at 44.5%. It's a really interesting bank because of the niche that it lives in, it lends primarily the people in New York City, to people who are looking for multifamily residences -- read that as apartment buildings. New York City is a great place to do that because of rent control. You know that your building is always going to be full of tenants, and you know those tenants are going to pay on time because they're living in some of the cheapest apartments in the city, and that means landlords always make their payments. And since New York Community Bancorp is operating in this very special environment, its costs are much lower, and its income is much more reliable than other banks, hence the very low efficiency ratio. Barring that, 55% is incredible.
Maxfield: Yeah, 55%, it's incredible, because U.S. Bancorp is more of a general-purpose bank. But I'm glad you brought up a New York Community Bancorp, because it illustrates a really important point. Let me pull up a little bit and give a broader perspective, and then we'll dig in a little bit more. I think it was in his 1990 shareholder letter, or 1991, where Warren Buffett -- and, I talk about Warren Buffett a lot in terms of banking because he really understands banking, perhaps more than anybody, but those great bankers I listed at the beginning of the show, Warren Buffett understands it more. He says, "If you want to outperform in an industry that is highly commoditized, like banking is, two things have to be the case. Either one, you have to have a niche product and earn outsized margins because you have expertise in that particular area that nobody else has; or, you have to be the low-cost producer. That New York Community Bancorp, it's in that niche area, and that's why it's been able to outperform the industry so much over the last few decades.
Here's what's so interesting about what Richard Davis has to say about the efficiency ratio and how that plays into how Warren Buffett sees banking. Richard Davis says, "You don't drive efficiency through lowering expenses. You drive efficiency through increasing your revenue." There's a great quote, let me pull that up. He says, "He who has the lowest efficiency ratio also often has the biggest revenue, which is in the denominator." And this is true. If you look at, not the efficiency ratio, but if you actually look at expenses as a percentage of assets, U.S. Bancorp's expenses as a percentage of assets is actually higher than a lot of these other big banks. But its revenue as a percentage of assets is much, much higher on a relative basis, relative to its expenses. That's why its efficiency ratio is so low. So then you say, "Look, how do you get your efficiency ratio so low?" And the answer to that, in U.S. Bancorp's case, is twofold. Number one, and this ties back into Buffett's point, Richard Davis says, "You have to go after businesses where," let me give you exactly what he said. "A bank needs to look at what it does and get into businesses where it can, one, be better than everyone else, two, where it has skills that no one else has, or three, where it can outperform its own history." He's basically saying, "Look, Warren Buffett's paradigm," and I don't think he meant to say like this, but this is how I look at it, "Warren Buffett's paradigm where if you want to outperform, you either have to be a niche operator or the low-cost operator, those two things are not mutually exclusive. In fact, you can be a low-cost operator by running it through a niche operation, because that will jack up your revenue and make your efficiency ratio go down."