Please ensure Javascript is enabled for purposes of website accessibility

1 Number More Important Than Earnings at Truist

By Bram Berkowitz – Oct 29, 2021 at 8:41AM

Key Points

  • The efficiency ratio is a bank's expenses expressed as a percentage of total revenue.
  • Truist projects its efficiency ratio will ideally be in the low 50s percentage range.
  • Truist is still a long way off from achieving its efficiency ratio goal, but confident it can reach it.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

The new bank resulting from the merger of BB&T and SunTrust has promised an industry-leading efficiency ratio.

Truist Financial (TFC -0.04%), the product of the blockbuster merger between SunTrust and BB&T, reported third-quarter earnings per share (EPS) of $1.20 on revenue of $5.6 billion earlier this month. Due to all the costs associated with the merger, the bank also tells investors what earnings would have looked like on a more normalized basis. Adjusted EPS would have been $1.42, which translates to a 1.51% return on assets (ROA) and a 22.6% return on tangible common equity (ROTCE), both of which are strong returns.

But beyond earnings, there is one longer-term metric I am watching at Truist that I believe is more important than these near-term, highly impacted earnings results.

Five people meet in a conference room overlooking a city.

Image source: Getty Images.

The efficiency ratio

As part of the merger, which was completed in December 2019, Truist promised to create a bank with industry-leading returns and an industry-leading efficiency ratio. The efficiency ratio is a measure of a bank's expenses expressed as a percentage of total revenue, so lower is better. Investors have rewarded Truist with a superior valuation for this reason. On an adjusted basis, Truist certainly seems to be on track for producing industry-leading returns in terms of ROA and ROTCE. But it's clear that there is still a good deal of work to be done in regards to achieving an industry-leading efficiency ratio in the low 50s percentile.

In the third quarter of the year, Truist had an efficiency ratio of nearly 68%, which is obviously very high due to all of the costs associated with integrating both banks. On an adjusted basis, the efficiency ratio was roughly 58%. Year to date, the adjusted efficiency ratio is 57%, so there is still a long way to go if Truist is going to hit the low 50s. There are a lot of expenses Truist is still planning to take out before it hits its total cost savings target laid out in prior merger plans. Management believes it will achieve its expected $1.04 billion of targeted cost savings by the end of this year. By the end of 2022, the goal is to achieve $1.6 billion of net cost savings.

But a lot has changed since announcing the merger. Truist has increased its merger-related costs and also upped its spending on operating expenses associated with the merger, including investments in technology. Truist had incurred $3 billion of those merger costs through the third quarter and has another $1 billion to go in 2022. These costs are nonrecurring, and I do believe they make sense long term, but they also may impact near-term targets.

However, when questioned by analysts about the efficiency ratio target, new Truist CEO William Rogers said he believes the bank will still achieve industry-leading efficiency. He also said that he felt confident in the low 50s percentage number, assuming an uptick in interest rates, which typically boosts bank revenue (the denominator in the efficiency ratio). Rogers added that he thinks the bank will be able to generate positive operating leverage next year, which is when the growth rate of revenue exceeds the growth rate of expenses.

Watch efficiency

I think hitting industry-leading efficiency ratio targets ideally in the low 50s will be important for Truist in maintaining its high valuation, and to potentially grow it. But there is still a lot of work to do in 2022 before the bank is done with its integration costs and can achieve the $1.6 billion in net cost savings. The revenue outlook and interest rate environment are by no means a certainty, either. Positive operating leverage next year will be a good start for Truist, but ultimately investors will want to watch the progress on cost saves and the efficiency ratio, which will be more important than near-term earnings results at the bank.

Bram Berkowitz has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.