Financial firms are becoming a smaller part of the U.S. economy as they deal with a past that won't go away and a future of lower revenue and fewer jobs. Persistent low interest rates and stagnant loan growth are shrinking interest income just as new regulations are putting a lid on the fees banks charge their retail customers. Net revenue at the six largest U.S. lenders—Bank of America (BAC), JPMorgan Chase (JPM), Citigroup (C), Wells Fargo (WFC), Goldman Sachs (GS), and Morgan Stanley (MS)—will probably fall 3.7 percent in the second quarter, the fourth year-over-year decline in five quarters, according to 100 analyst estimates compiled by Bloomberg. Regulations requiring banks to hold more capital as a cushion against losses are likely to crimp profitability. "You don't have to be a scientist to figure out that tighter regulation and more onerous capital rules without economic growth will shrink the industry," says John Garvey, head of the financial industry advisory practice at PricewaterhouseCoopers. Financial companies accounted for 29.3 percent of U.S. corporate profits over the 12 months ended Mar. 31, well off the record high of 41.7 percent set in the 12 months ended Sept. 30, 2002.
Investors don't like what they see. Financial stocks have trailed the broader market for 9 of the last 11 months. The ratio of the price of the Standard & Poor's 500 financials index to the S&P 500-stock index is less than 0.16, down from a peak of 0.36 in March 2004. The only other time in the last 20 years the ratio dropped below 0.16 was a stretch from January to April 2009, when some banks faced nationalization after taking billions in rescue funds to survive the credit crisis. Bank of America, the biggest U.S. lender by assets, saw its stock hit a two-year low on June 6.
Analysts including Meredith Whitney and Nomura Holdings' (NMR) Glenn Schorr expect the slow growth to result in job cuts on Wall Street in the coming months. The number of U.S. financial-industry jobs dropped for the fourth straight year to an average of 7.63 million in 2010, according to the Bureau of Labor Statistics. That's 8.4 percent below the 2006 peak, and the figure fell to 7.61 million in May.
Banks face at least 15 major "overhangs" to performance over the next few years, FBR Capital Markets (FBCM) analysts wrote in a June 3 note to investors. Among the factors cited were new limitations on proprietary trading and debit-card swipe fees; state and federal investigations into mortgage practices; and stricter capital and liquidity requirements. New rules set by the Basel Committee on Banking Supervision, which will begin to take effect in 2013, may trim the return on equity of U.S. banks by 3 percentage points, according to estimates by McKinsey consultants. "Those are pretty big clouds, there's no arguing with that," JPMorgan Chief Executive Officer Jamie Dimon said at an investor conference in New York on June 2. At a bank conference in Atlanta on June 7, Dimon asked Federal Reserve Chairman Ben S. Bernanke whether new bank regulations have gone too far. Bernanke answered that it's probably going to take a bit of time before regulators "figure out where the cost exceeds the benefits."
In an effort to boost revenue, banks are shifting their focus back to bread-and-butter businesses, such as retail banking, brokerage services, and asset management. They are dusting off a once-favored strategy, cross-selling—persuading existing customers to buy additional products. Morgan Stanley has hired more than 170 private bankers to make loans and offer deposit products to its retail brokerage clients. Bank of America is looking to win banking business from the two-thirds of its Merrill Lynch customers who have bank accounts with other lenders. Wells Fargo is building its retail brokerage so that it can capture business from 5.2 million clients who hold $1.7 trillion in investment assets at other firms. Says PricewaterhouseCoopers' Garvey: "Right now in the U.S., it's much more about carving up the pie a different way rather than growing the pie."
The country's biggest banks are looking for growth overseas, particularly in emerging markets. Citigroup CEO Vikram Pandit said at a Mar. 9 conference that the bank now gets more than half of its profit from emerging markets. "We have a unique footprint that we believe will allow us to harness global growth trends and deliver value to our client and shareholders over time," says Shannon Bell, a Citigroup spokeswoman. Spokesmen for the other five banks declined to comment or didn't return calls.
Bank of America CEO Brian Moynihan said in February that his bank would try to produce revenue increases that outpaced the growth of the U.S. economy by 1 percentage point, driven by its international operations. Goldman Sachs Chief Operating Officer Gary Cohn said this month that his firm's hiring efforts are concentrated on China, India, and Brazil.
The banks will face political obstacles and strong local competition, while earning lower fees than they command in the U.S. "We expect to continue to see ferocious competition in these markets," analysts from Oliver Wyman and Morgan Stanley said in a March research paper. "Rising costs and falling yields will mean less of the top-line growth comes through to the bottom line."
The bottom line: Banks have seen revenue fall in three of the past four quarters. Many hope that cross-selling and overseas growth can help right the ship.