A Weak Economy Takes the Air Out of Bank Earnings
When the financial crisis hit and the economy swooned, Washington first focused on saving the banking industry. Two U.S. Treasury Secretaries and Federal Reserve Chairman Ben S. Bernanke funneled capital and cheap loans to banks with the goal of boosting lending and powering a robust economic revival. It hasn’t worked out that way. While those policies benefited Wall Street, they failed to produce a sustained recovery on Main Street, where the unemployment rate remains above 9 percent. Now a struggling U.S. economy may sap bank earnings and lead to industry job losses and lower stock prices. “The political class is fixated on how the banking system caused the problem in the first place and therefore how it will have to cure it in the future—that if you get the banks working again, the economy works,” says Robert B. Albertson, chief strategist at Sandler O’Neill & Partners in New York. “It drives me into silly laughter. It’s the other way around.”
The nation’s gross domestic product grew at a 1.3 percent annual rate in the second quarter and 0.4 percent in the first quarter, the Commerce Dept. reported July 29. Combined first-half earnings at the 15 largest U.S. banks by assets dropped 17 percent from a year earlier, led by declines at four of the six biggest. While the average estimates of analysts surveyed by Bloomberg show they still expect second-half earnings at the 15 lenders to climb 88 percent from the same period in 2010, some investors are dubious. “I don’t think economic reality has hit estimates yet,” says Matthew D. McCormick, a portfolio manager at Cincinnati-based Bahl & Gaynor who helps manage about $4 billion and doesn’t own any of the biggest U.S. bank stocks. “I’ve got to believe that this is going to be a tough quarter.”
Investors are abandoning the sector. Bank of America, the largest U.S. bank by assets, has seen its stock fall 53 percent this year through Aug. 23. JPMorgan Chase, the second-biggest bank, has dropped 18 percent. The 24-member Keefe, Bruyette & Woods Bank Index has declined 21 percent since July 28, the day before the latest GDP figures were reported, compared with an 11 percent retreat in the Standard & Poor’s 500-stock index.
Of course, the banking system and the economy might be in worse shape if not for the policies enacted by Bernanke, former Treasury Secretary Henry M. Paulson Jr., and his successor Timothy F. Geithner. The Fed provided as much as $1.2 trillion in loans to banks and other companies beginning in August 2007, slashed its main U.S. interest rate as low as zero in December 2008, and has engaged in two rounds of purchasing bonds in what’s known as quantitative easing. In October 2008, Treasury began injecting equity capital into banks by purchasing preferred stock. U.S. banks are better prepared to withstand a crisis than they were in 2008 because of the capital and liquid assets they’ve accumulated, according to analysts including Richard Ramsden at Goldman Sachs. “The risk to bank earnings from here therefore appears to be more about an extended low-rate, low-growth environment,” Ramsden and his team wrote in an Aug. 11 note to investors.
Feeble economic growth reduces demand for loans from consumers and businesses, and low interest rates compress the profit on loans the banks do make. In this environment, any growth may have to come at the expense of competitors, says Peter Kovalski, a portfolio manager and bank industry analyst at Alpine Woods Capital Investors who manages about $6 billion. “The overall pie hasn’t increased yet,” he says.
Revenue at the biggest banks is unlikely to be boosted by their Wall Street activities. First-half investment banking and trading revenue declined to $91 billion at the top 10 global banks, from $93 billion a year earlier, according to an Aug. 16 report from industry consultant Coalition Ltd.
The 50 biggest banks have announced more than 60,000 job cuts this year, according to company statements and data compiled by Bloomberg Industries. UBS, Switzerland’s biggest lender, said on Aug. 23 that it will cut about 3,500 jobs, or 5.3 percent of the workforce, to reduce expenses. Bank of America CEO Brian T. Moynihan said in a memo to senior managers on Aug. 19 that the company will eliminate about 3,500 jobs this quarter in addition to 2,500 cuts made earlier in the year.
Not all banks will suffer. Even though he reduced his estimate for JPMorgan’s 2012 revenue by 2.4 percent, Atlantic Equities analyst Richard Staite raised his recommendation on the stock to “overweight” because he thinks the bank has an opportunity to win market share, especially against European lenders that may pull back because of that region’s sovereign debt crisis. Even in the U.S., he says, “they have a program to open 2,000 new branches, so you’re seeing them expand across all of their business lines.”
Citigroup, the third-biggest bank by assets, also will be less affected than rivals by the U.S. economy, Staite says. CEO Vikram Pandit has said the bank, excluding businesses tagged for sale or closure, derives more than half its profit from emerging markets. European banks “will maybe rein in some of their growth ambitions for Asia, and Citigroup, which already has a strong business in these areas, will hold on to their market share,” Staite says.
Most bank stock prices have fallen further than even the gloomier earnings outlooks warrant, says Sandler O’Neill’s Albertson. Still, investors will need to continue to look at the economy itself for signs that banks’ prospects are really brightening, he says: “Lending does not create economic growth—economic growth creates lending.”