JPMorgan Chase & Co., likely to keep the title of most profitable U.S. bank when it reports earnings tomorrow, has a West Coast rival closing in: Wells Fargo & Co.
JPMorgan is projected to report a record $18.5 billion in 2011 earnings when adjusted for one-time items, a 6 percent increase for the New York-based company, according to a survey of analysts by Bloomberg. Profit at San Francisco-based Wells Fargo is estimated to have jumped more than four times as much, to an all-time high of $15.3 billion.
By focusing on the U.S. and eschewing traditional Wall Street businesses such as structured products, Wells Fargo surpassed earnings at Goldman Sachs Group Inc. and Citigroup Inc. for six consecutive quarters. Wells Fargo, whose $1.3 trillion in assets make it the fourth-largest U.S. bank, also has higher valuations than its bigger peers.
Wells Fargo “never really embraced investment banking as heavily as the Wall Street crowd has,” said Paul Miller, a former examiner for the Federal Reserve Bank of Philadelphia and analyst at FBR Capital Markets in Arlington, Virginia. “I think one of the reasons Wells is where they are right now is because they did not get into that business” in a bigger way, he said.
The strains on investment banking will be apparent in JPMorgan’s fourth-quarter profit, as well as weak trading results predicted for its smaller competitors when they report earnings next week, Miller said.
Wells Fargo is being rewarded for its restraint with a market value of $156.2 billion, compared with $139.3 billion at JPMorgan and $91.4 billion at No. 3 Citigroup. Only Goldman Sachs trades at a higher price-to-earnings ratio than Wells Fargo among the biggest U.S. lenders, at 10.76 versus 10.25. The higher the ratio, the faster investors think the company’s profit will grow.
“Traditional banking, predominantly making loans and taking deposits and serving both corporate and individual consumers, is being viewed more favorably right now by the investor community,” said Ed Najarian, who runs bank research at International Strategy and Investment Group in New York. “It’s considered safer and to have a steadier and more consistent earnings outlook.”
Wells Fargo has dropped 7.5 percent in New York trading in the past 12 months, compared with declines of 18 percent for JPMorgan and 54 percent for Bank of America Corp. Wells Fargo rose to $30 at 7:37 a.m. in New York from $29.62 yesterday, while JPMorgan climbed to $37.13 from $36.66.
Wells Fargo, which reports earnings on Jan. 17, owes its relative good fortune partly to Europe’s sovereign debt crisis, which slammed investment-banking results in the second half of last year at JPMorgan, Goldman Sachs and other firms with large trading desks and international divisions.
JPMorgan, the biggest U.S. bank by assets, will probably report a 23 percent slump in fourth-quarter adjusted profit from the same period in 2010 to $3.74 billion, or 90 cents a share, according to the survey. Analysts lowered their estimates after Chief Executive Officer Jamie Dimon, 55, said at a Dec. 7 investor conference that trading would be “essentially flat” from the third quarter.
Revenue at the company’s investment-banking unit slid this year from $8.2 billion in the first quarter to about $4.5 billion in the third after backing out a $1.9 billion one-time accounting gain as concern mounted that Greece would default and U.S. lawmakers would fail to raise the debt ceiling. JPMorgan told investors in October that the division would face similar market conditions for the rest of the year.
Trading results got a lift in the third quarter as the price of bank debt fell, resulting in a so-called debt-valuation adjustment that boosted profits for JPMorgan, Goldman Sachs and Citigroup. The accounting adjustment probably hurt banks in the fourth quarter as price of their debt rose, resulting in the opposite effect on earnings.
“Trading and investment-banking revenue has been weak and volatile, especially over the last two quarters, but really the last two years,” Najarian said. Investment-banking results will be worse for the fourth quarter than in the third quarter, he said.
Overall revenue at JPMorgan is expected to drop 13 percent for the quarter and 4 percent for the year, to $98.9 billion. Fixed-income trading revenue at U.S. banks may fall 12 percent from the third quarter, minus accounting adjustments, while equities revenue drop 10 percent and investment-bank revenue remains unchanged, David Trone, an analyst at JMP Securities, wrote in a Dec. 16 report.
Markets showed little improvement in the fourth quarter, as trading remained subdued, corporate and institutional clients stayed out of the markets and the holidays slowed deal and trading traffic.
Lenders will continue to face pressure from persistently low interest rates, which have compressed profit margins on lending. They’ll also have to contend with new restrictions on fees.
The so-called Durbin amendment, which limits what lenders can charge merchants on debit transactions, took effect on Oct. 1, affecting almost all U.S. banks and costing the top 25 about $1.5 billion, according to Jason Goldberg, a senior bank analyst at Barclays Capital in New York.
Wells Fargo “avoided a lot of the trash that others kind of fell into leading into the 2008 financial crisis,” Goldberg said in an interview. The company, led by CEO John Stumpf, 58, will see its fee revenue fall by about $350 million and JPMorgan will lose roughly $300 million, Goldberg estimated.
“The big issue for the banks is, is this a cyclical or a secular problem? And the answer is, it’s both,” said Richard Bove, an analyst at Rochdale Securities LLC in Lutz, Florida. Bove said U.S. lenders are starting to perform more like utilities with smaller growth rates and less leverage. Goldman Sachs may never generate 10 percent or 12 percent growth rates again, he said.
“It’s not going to happen because the leverage in the balance sheet is gone, the off-balance-sheet conduits are illegal, the variable-interest entities are limited, the structured-investment vehicles are gone,” Bove said, referring to the types of securities that helped trigger the U.S. economic crisis. “The leverage isn’t there and the market isn’t there.”
Large super-regional banks such as Wells Fargo and Pittsburgh-based PNC Financial Services Group Inc. will probably fare better as the basic business of taking deposits and making loans gives reason for optimism, Goldberg said. Lending at U.S. banks was up 2.1 percent from the third to the fourth quarter while deposits rose 5.6 percent, according to Federal Reserve data. Goldberg said the growth offset slimmer profit margins in the fourth quarter.
“In this quarter you’re going to see dramatically different results in each segment, with the traditional banks having the best performance and the capital markets having the worst,” Bove said.
Mike Mayo, an analyst with independent research firm CLSA in New York, said U.S. banks are in the middle of the industry’s worst two years of revenue growth since the Great Depression. Earnings for the fourth quarter will be weak and won’t see much improvement this year, he said.
Friday the 13th
“Friday the 13th will live up to its name when it comes to bank earnings,” Mayo said in an interview yesterday at Bloomberg’s headquarters in New York promoting his new book, “Exile on Wall Street.” When banks start reporting results with JPMorgan tomorrow, “you’re going to see all sorts of revenue and margin pressure and the results will be underwhelming.”
Bank of America, second by assets to JPMorgan, will probably post $5.84 billion in adjusted earnings for the year, a 63 percent plunge from 2010, according to the Bloomberg survey.
Citigroup’s 2011 profit was estimated at $11.8 billion, or 13 percent higher than the previous year, and Goldman Sachs is projected to report a 57 percent decline to $3.35 billion. Morgan Stanley, the sixth-largest U.S. bank, may post $2.23 billion of adjusted earnings, down 28 percent. All three companies are based in New York.