JPMorgan to Citigroup Profit Eclipsed by Bernanke’s QE PurchasesDawn Kopecki
Federal Reserve Chairman Ben S. Bernanke’s plan for paring central bank bond purchases will squeeze profit and erode capital through 2014 at the six largest U.S. lenders, overshadowing second-quarter earnings that are projected to rise by an average of 20 percent.
Market gyrations that began mid-quarter damped earnings at firms including Goldman Sachs Group Inc. and Bank of America Corp., analysts’ estimates show. Trading and home-lending that started strong slumped after Bernanke indicated May 22 that the Fed could slow monthly bond purchases as employment improves. JPMorgan Chase & Co., the largest U.S. bank, and Wells Fargo & Co. report results tomorrow, followed by competitors next week.
U.S. banks’ unrealized gains on available-for-sale securities dropped by $30.3 billion from May 1 through June 26 as the value of corporate and other types of bonds fell, according to Fed data. That will reduce bank equity and weaken regulatory capital, potentially suppressing dividends and share-buyback programs, according to Moody’s Investors Service.
“The problem isn’t so much this quarter, which I think will be OK,” said Christopher Wheeler, an analyst at Mediobanca SpA in London. “What is important is what happens in the third and fourth quarter. I fear we may see a quieter summer than we’ve seen in some time -- what I call a wait-and-see summer.”
While Bernanke’s comments may have a more dramatic impact on banks’ capital, they also are leading analysts to lower full-year earnings projections. Average estimates for Bank of America’s 2013 profit fell $314 million to $11.2 billion since he spoke, according to data compiled by Bloomberg. Estimates for Morgan Stanley dropped $177 million to $3.8 billion.
Corporate bonds and Treasury securities lost an average of 4 percent and 3.16 percent in value, respectively, since Bernanke’s remarks, Bank of America Merrill Lynch index data show. Long-term interest rates, as measured by 10-year Treasury yields that are used to set rates for some consumer and corporate loans, rose from this year’s low of 1.63 percent on May 2 to 2.74 percent on July 5, the highest since August 2011.
U.S. regulators added to the pressure on big banks this week when they proposed leverage rules that would require eight of the largest lenders to hold a minimum capital level equal to 5 percent of their assets, while some subsidiaries would have to hold 6 percent. Banks below those requirements may hoard earnings to make up the shortfall.
The market swings and capital rules cap a 22-month rally in the KBW Bank Index, which has climbed 81 percent since September 2011 on signs the U.S. economy and housing market are strengthening. Analysts predict banks’ profits to rise in the second quarter after year-earlier results were hurt by Europe’s sovereign-debt crisis, costs from soured mortgages and, at JPMorgan, a wrong-way bet on derivatives.
The 20 percent average increase in profits at the six largest banks ranges from 9 percent at San Francisco-based Wells Fargo to 55 percent at Goldman Sachs, according to analysts’ estimates compiled by Bloomberg.
JPMorgan’s net income probably rose 14 percent to $5.66 billion from a year earlier, according to the average estimate of analysts surveyed by Bloomberg. Wells Fargo’s profit is seen climbing to $5.05 billion. Citigroup Inc. may report a 22 percent increase to $3.6 billion next week as Charlotte, North Carolina-based Bank of America’s earnings rise 26 percent to $3.1 billion, the estimates show.
Bernanke’s remarks prompted analysts to change projections for banks most reliant on trading. Fifteen of 26 analysts tracking New York-based Goldman Sachs lowered their estimates in the past four weeks, predicting net income of $1.5 billion. Seventeen of 26 analysts covering Morgan Stanley cut their estimates, predicting $881 million in earnings. That’s still a 49 percent jump from a year earlier.
Analysts are reducing projections partly because U.S. accounting rules require banks to mark their trading portfolios to market, recording the gains and losses in earnings. Goldman Sachs has the largest trading book among the biggest banks at $387.9 billion, followed by Citigroup at $265.2 billion, according to data compiled by Guggenheim Partners. JPMorgan has $250.5 billion in trading assets and Morgan Stanley $248.4 billion, the data show. All four firms are based in New York.
Changes in the value of securities categorized as available-for-sale, or AFS, as opposed to trading, flow through a bank’s balance sheet as shareholder equity and not through the income statement. That affects regulatory capital for the biggest banks and could force firms to limit shareholder payouts such as dividends while they build capital. Rising interest rates erode those buffers as well as earnings because bonds held on their books, which generally pay lower yields, fall in value.
Accounting rules require banks to categorize securities as trading, AFS or held-to-maturity, which determines where firms record gains and losses and how quickly they hit the balance sheet and earnings. Unrealized losses on most held-to-maturity securities don’t have to be recognized, while changes in the value of AFS securities affect shareholder equity. Falling values in trading portfolios can immediately hurt earnings.
Banks may be able to offset some losses by hedging securities held in their inventory.
“The unrealized losses on their securities books, these companies are going to be taking it on the chin,” said Paul Miller, an analyst at FBR Capital Markets in Arlington, Virginia, and a former examiner for the Federal Reserve Bank of Philadelphia. “It forces some of these banks to hold more capital than they need for a quick rise in rates.”
Mortgage-fee revenue for leading home-lenders, such as Wells Fargo, Bank of America and JPMorgan, also is projected by analysts to fall.
Refinancings, which accounted for 76 percent of last year’s $1.75 trillion in loan originations, slumped after rates on 30-year loans jumped from an average of 3.51 percent the week before Bernanke spoke to 4.46 percent at the end of June, data compiled by Freddie Mac show. Refinancing applications fell 42 percent from May 17 to July 5, according to Joel Kan, an economist at the Mortgage Bankers Association, a Washington-based trade group.
Wells Fargo, the nation’s largest home-lender, may suffer more than others. Chief Executive Officer John Stumpf, 59, relied on revenue from home loans for 14 percent of the bank’s total revenue last year as it posted a third-straight record annual profit.
Mortgage revenue at Wells Fargo may drop as much as 15 percent in the second quarter from $2.79 billion in the first three months, Matt O’Connor, a New York-based analyst with Deutsche Bank AG, estimated in a June 27 note. Full-year mortgage-origination revenue may slide as much as 39 percent to $7.5 billion, Richard Staite, an Atlantic Equities LLP analyst, wrote June 12.
Securities markets were so robust before May 22 that JPMorgan CEO Jamie Dimon, 57, told investors June 11 the bank’s trading revenue will still rise by at least 15 percent from $4.5 billion in the same quarter last year.
One bright spot was corporate-bond issuance, which surged 18 percent to $914 billion in the second quarter from last year, data compiled by Bloomberg show. Equity issuance jumped 24 percent from a year ago to $72.4 billion in the second quarter. That won’t continue, said Mediobanca’s Wheeler. In the weeks after Bernanke’s remarks, new bond and equity deals have “fallen off a cliff,” he said.
Banks need short-term and long-term rates to rise in tandem to boost profit since so many of their assets are paying historically low yields and are tied to overnight, 1-month, 3-month and other short-term benchmark rates, said Joe Pucella, an analyst at Moody’s. Higher short-term rates are good for banks in the long run because banks can charge more for those loans, which increases their margins on lending.
“A rise in rates will create noise in banks’ results, and you’ll see that play out over the next several quarters,” Pucella said. The amount of pain banks will feel depends “on how long and how quickly it takes for rates to rise. If rates continue to rise, we think it will play out over the next 12 to 18 months.”
The European Central Bank, the Fed and other central banks have sought to boost their economies by lowering interest rates and purchasing securities, referred to as quantitative easing. Bernanke said the Fed would consider slowing down its bond purchases once the U.S. unemployment rate drops below 7 percent. That has caused long-term rates to rise, while the central bank has kept short-term rates near zero since 2008.
Fed officials said they plan to keep them there until unemployment drops to 6.5 percent, which they don’t expect until 2015. The U.S. jobless rate stood at 7.6 percent at the end of June.
“There’s been a lot of excess liquidity as a result of quantitative easing by the U.S., the U.K., the ECB and now, since March, Japan,” Wheeler said. “What goes up must come down. If you just take out that excess liquidity, you’ve got to pay it back somehow.”
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