There are two ways a bank can cannibalize revenue and, by implication, shareholder return: They can underwrite bad loans and/or operate inefficiently -- that is, to allow expenses to consume too much revenue.
While the former isn't a problem at BB&T (NYSE:BBT), the nation's eighth largest bank by assets (excluding investment and custodial banks), the latter is certainly starting to become one.
You can see this in the chart below, which was taken from a presentation that BB&T's CEO Kelly King gave at a recent industry conference. The figure tracks BB&T's estimate of its efficiency ratio, generally computed by dividing noninterest expenses by net revenue, compared to those of a handful of its peers.
While BB&T's peer group has seen a slight decrease in its average ratio, going from 63.4% in the second quarter of last year down to 63.2% one year later, BB&T's has been on a consistent march upward, increasing by nearly four percentage points.
If you're a BB&T shareholder, this should concern you, as a higher efficiency ratio means there's less revenue left over for dividends, buybacks, or growth in book value.
A textbook example of this is Bank of America (NYSE:BAC), which, like BB&T, is also headquartered in North Carolina. Over the past five quarters, its efficiency ratio has averaged out at 77.6%, making it the least efficient of the nation's largest consumer-oriented banks. Not coincidentally, it's also been the least profitable, with an average return on equity of 3.07% since the second quarter of last year.
The good news is that BB&T, by its own calculation anyhow, continues to outperform its peer group by leaps and bounds when it comes to efficiency -- though, for the record, according to my own more conservative calculation of BB&T's efficiency ratio, it outperforms its peer group by a considerably smaller margin of 2.3 percentage points.
In addition, there are rational explanations for the alarming trend. First, BB&T is diversifying away from straight-up banking, pushing ever more heavily into the less cost-efficient insurance space in particular. "That's not bad," King noted during his presentation, "that's just a mix change."
And second, the bank is in the process of installing a new general ledger system, which King believes will ultimately fuel efficiency as opposed to detract from it. As he noted, "even though you have the run rate cost of that new system, you get lots of efficiencies because you have a new general ledger system versus a 25-year-old system."
Together, the bank estimates that its second-quarter expenses were elevated by $62 million. When all is said and done, in turn, BB&T's target rate for its efficiency ratio is in the "low- to mid-50s."
Now, let me be clear, there's absolutely nothing wrong with an efficiency ratio in this range. In an article I wrote last week about U.S. Bancorp (NYSE:USB), I noted its 51% efficiency ratio for the fiscal year of 2012. By comparison, the average of the 14 largest traditional banks in the United States was 63%. This is why I referred to U.S. Bancorp's efficiency as "simply unparalleled."
But what remains to be seen is whether BB&T can actually get it back down to that level and, if it is indeed successful, how long it takes to get there.
John Maxfield owns shares of Bank of America. The Motley Fool recommends Bank of America. The Motley Fool owns shares of Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.