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5 Lean and Mean Bank Stocks

NEW YORK ( TheStreet) -- Yes, the government is shutting down, but after Congress and President Obama settle on a budget and again raise the federal debt ceiling, bank executives will still be talking about their efforts to contain costs.

Using data supplied by Thomson Reuters Bank Insight, TheStreet has identified the five actively traded U.S. banks with the lowest (best) efficiency ratios over the past year. The efficiency ratio is, essentially, the number of pennies of overhead expense a bank incurs for each dollar of revenue.

During the years of recovery from the U.S. credit and real estate crisis, banks have faced plenty of revenue pressure from narrowing net interest margins and low demand for many types of loans, while expenses tied to working out problem loans and disposing repossessed assets were elevated. At this point in the cycle, banks still have "credit leverage," as their earnings are boosted by the release of loan loss reserves and expenses are coming down as loan servicing staff levels are cut.

But many banks will report major declines in mortgage banking revenue for the third quarter, as the mortgage refinancing boom is ending; the Mortgage Bankers Association forecasts an even sharper drop in lending volume next year.

According to the MBA's latest forecast last week, refinance volume for one-to-four family mortgage loans will drop from $1.247 trillion in 2012 to $989 billion in 2013 and $388 billion in 2014. Overall volume for mortgage loan refinancing is forecast to decline from $1.750 trillion in 2012 to $1.605 trillion this year, with a much sharper decline to $1.091 trillion in 2014.

Atlantic Equities analyst Richard Staite in a report on Sept. 23 estimated third-quarter mortgage production revenue for the eight large-cap U.S. banks he covers -- including Wells Fargo (WFC - Get Report), JPMorgan Chase (JPM), Bank of America (BAC - Get Report), Citigroup (C), Goldman Sachs (GS), Morgan Stanley (MS), PNC Financial Services Group (PNC) and U.S. Bancorp (USB) -- will plunge 55% from a year earlier. He expects mortgage origination revenue for the group to drop 45% from the second quarter.

Adding fuel to the fire, Staite also forecasted a 20% drop in fixed-income trading revenue for the large-cap group, because "July and August were very slow months as investors sat on the sidelines waiting for more clarity on Fed tapering, Syria and the EM slowdown and we believe the weakness has extended into September."

Wells Fargo -- the nation's leading mortgage lender -- announced 4,800 layoffs of mortgage production staff during the third quarter, citing the decline in refinance volume. While the layoffs are terrible for the affected employees, they are just what investors want to hear.

As the strongest and most consistent earnings performer over the past five years among the large-cap banks listed above, Wells Fargo has long emphasized efficiency. The company's head of mortgage lending, Franklyn Codel, at a conference in May emphasized the natural offset to a decline in revenue, since his unit's sales staff is 100% commission-based and he frequently reviews staff levels as volume changes.

Wells Fargo's second-quarter efficiency ratio was 57.73% in the second quarter, improving from 58.76% the previous quarter and 58.73% a year earlier, according to Thomson Reuters Bank Insight. During the company's second-quarter earnings conference call, Wells Fargo CFO Timothy Sloan said "We expect our efficiency ratio to remain within our target range of 55% to 59%."

Bank of America laid off 2,100 employees during the second quarter, according to various media reports, and the company under the leadership of CEO Brian Moynihan continues its long-term "Project New BAC" cost-cutting program, which is meant to trim annual expenses by $8 billion from 2010 levels. The company expects the annual savings rate to reach $6 billion by the end of this year.

But with overall earnings still weak, Bank of America's efficiency ratio isn't a very impressive indicator. The second-quarter efficiency ratio was 69.80%, improving from 74.77% in the first quarter and 74.56% in the second quarter of 2012. Bank of America will announce its third-quarter results on Oct. 16, with analysts polled by Thomson Reuters estimating the bank will report earnings of 19 cents a share. In comparison, the company earned 32 cents during the previous quarter and posted a small net profit, for EPS of zero cents, in the third quarter of 2012.

Raymond James analyst Anthony Polini on Monday reiterated his "strong buy" rating for Bank of America, with a price target of $16.50, "given our positive fundamental outlook and the stock's attractive valuation." The analyst estimates Bank of America's earnings will rise considerably from 98 cents a share this year to $1.34 a share in 2014.

Using the data supplied by Thomson Reuters Bank Insight, we have identified the five actively U.S. traded banks -- with average daily trading volume of at least 40,000 shares -- with the lowest efficiency ratios. All five names are solid earnings performers that have seen strong year-to-date returns, with four beating the return of the KBW Bank Index (I:BKX), which was up 22% year-to-date through Friday's market close.

Here they are, by descending (improving) efficiency ratio:

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