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In the banking industry, a bank’s efficiency ratio more or less represents what a bank has to spend to generate a dollar of revenue.

According to a study entitled Efficiency Ratios and Community Bank Performance by Hays, De Lurgio, and Gilbert that appeared in the Journal of Finance and Accountancy:

The efficiency ratio measures the level of non-interest expense needed to support one dollar of operating revenue, consisting of both interest income and non-interest or fee income. The value of the efficiency ratio can be influenced by changes in salaries and benefits, labor productivity, technology, utilization of physical facilities especially branch offices along with many other factors including economies or diseconomies of scale.

The study defined efficient banks as having an efficiency ratio of 51 or less and an inefficient bank with having an efficiency ratio of 81 or higher. The study was based on banks with Capital assets of less than $1 Billion dollars. International Bancshares Corporation (IBOC) has assets in the neighborhood of $11 Billion dollars. Thus one might not expect the study could be used to analyze IBOC’s efficiency rating. However the study included a chart that noted from the year 1999 through 2008, Banking Efficiency Ratios for banks with under $1 Billion dollars in assets saw their efficiency ratios climbing, while banks with assets with more than $1 Billion dollars in assets saw their efficiency ratios declining.

The following chart is based on the study’s graph:

Assets

Assets

Year

<$1 Billion

>$1 Billion

Gap

1999

63.5

57.43

6.07

2000

63.78

57.38

6.4

2001

65.53

56.43

9.1

2002

64.31

54.77

9.54

2003

65.69

55.07

10.62

2004

64.57

56.35

8.22

2005

63.78

56.35

7.43

2006

64.8

55.7

9.1

2007

67.37

58.46

8.91

2008

71.46

57.41

14.05

Let’s examine IBOC’s Efficiency Ratio (from federal banking data).

Efficiency Ratio

9/30/2011

61.14

9/30/2010

66.25

12/31/2010

63.62

12/31/2009

53.74

12/31/2008

58.91

Comparing the chart above for 2008, one can see that IBOC’s efficiency rating was in line with other banks with assets over $1 Billion dollars. Its efficiency rating improved in 2009 but jumped dramatically in 2010, and appears to be easing back down in 2011.

Comparing IBOC’s efficiency rating with its peer group banks we find the following:

Peer

IBOC

Average

9/30/2011

61.14

61.74

9/30/2010

66.25

60.9

12/31/2010

63.62

61.67

12/31/2009

53.74

64.94

12/31/2008

58.91

65.64

The data clearly show that IBOC’s efficiency rating began to decline the past three years, but it appears efforts are being made to improve it. For IBOC shareholders, this metric should be watched over the next couple of years as it indicates improvement in management of the bank’s profitability and may help identify signs of an economic recovery. If IBOC could get this back down under 55, it would be impressive.

Caveat: A Bank’s efficiency ratio is one metric of many that investors can use when analyzing a bank. Just keep in mind that every banking institution is managed by varying management styles and philosophies, some more risk averse than others. Observing one piece of data from one point in time may not accurately reflect the totality of a bank’s performance.

Disclosure: No positions. I am considering IBOC as a long term investment in the future as a play on the recovery of the border economy.

Source: Is IBOC An Efficient Banking Establishment?