Bank earnings mask lingering problems

Increases in profits came mainly from cutting costs as core lending businesses lag
A Bank of America branch is seen along Peachtree Street Tuesday in Atlanta. Bank of America Corp. reported on Wednesday that its quarterly earnings are up 70 percent.AP

NEW YORK — Major U.S. banks have turned in big profit gains this season, but the news isn't all good.

Much of the earnings increase is coming from cutting costs, rather than growing their core lending businesses. A boom in mortgage refinancing looks like it's about to peter out. And regulators are considering stricter rules that would force the banks to shore up their cash.

"It was a very good quarter with headline numbers better than expected," said Anthony Polini, an analyst at Raymond James.

But, he added, "the jury is still out" on the second half of the year. And he, for one, isn't overly optimistic: Polini thinks that revenue from mortgages and trading activities, which helped earnings this time around, will suffer through the end of the year, and he questions whether the U.S. economy can grow enough to support anything more than sluggish loan demand.

Bank of America reported second-quarter earnings Wednesday, following JPMorgan Chase and Wells Fargo last week and Citigroup on Monday.

Here's more on what to take away from the season:

THE HEADLINE NUMBERS: There's no denying that profits popped compared with a year ago. At Wells Fargo, whose profits grew by the smallest amount, earnings rose 20 percent. At Bank of America, they went up 70 percent. The bank said it earned $3.6 billion for shareholders in the second quarter. At 32 cents per share it's the highest it's been since fall 2011.

The problem is that it wasn't revenue growth that was driving the earnings. Revenue basically was flat at Wells Fargo, up 3 percent at Bank of America, 8 percent at Citi (where earnings rose 26 percent) and 14 percent at JPMorgan (where earnings rose 32 percent).

WHERE EARNINGS CAME FROM (AND DIDN'T COME FROM): There were several big factors driving second-quarter earnings growth.

The banks were able to set aside less money for potential bad loans because consumers are defaulting on loans less often and because banks have gotten stricter about who they make loans to — though that's a double-edged sword, because making fewer loans also means lower revenue.

Banks also have benefited from a recent increase in interest rates, which means they can charge higher interest on their loans.

Investment banking units also did well. Though there was uncertainty through part of May and June about how long the Federal Reserve will continue its support for the U.S. economy — causing turbulence in stock and bond markets — banks were still able to enjoy higher revenue from trading for their clients and book gains on their own stock investments.

Besides, volatile markets aren't all bad: Many bank clients see it as a prime time to trade, or will want help recalibrating their investment strategies.

On the other hand, results from consumer banking have tended to be sluggish, a troubling sign in an economy built mostly on consumer spending.

Loan growth across the banking industry is down so far this year, and the industry's loan-to-deposit ratio is at its lowest since 1984, added CLSA analyst Mike Mayo.

"This is not the stuff that robust recoveries are made of," Mayo said.

PENNY PINCHING: Banks also were able to earn more money because they slashed costs.

Notably, Bank of America cut about 18,300 jobs over the year, or nearly 7 percent of its workforce. It also got rid of about 5 percent of its branches, and promised to cut more.

JPMorgan and Citigroup also cut jobs, and reeled in spending on equipment, offices, advertising and marketing.

Some analysts questioned how long cost-cutting can continue to prop up earnings; there's only so much a company can cut before it becomes counterproductive.

THE REFINANCING BOOM: Mortgages have helped drive results at the banks for the past year, but it's not clear how much longer that will last. Most of the boom has come from people refinancing their mortgages, rather than buying new homes, and that is likely to peter out as interest rates rise.

In a call with analysts, JPMorgan's chief financial officer, Marianne Lake, said that if rates stay at or above their current levels, the mortgage refinancing market could be slashed by 30 to 40 percent — more than analysts were expecting.

THE REGULATORY OVERHANG: Another hot topic during bank earnings was the so-called leverage ratio.

Last week, U.S. regulators proposed rules that would require big U.S. banks to hold greater levels of capital. The regulators say that having more cash on hand will protect banks in troubled times.

While the new rules wouldn't take effect until 2018, and the banks said they are already at or near many of the proposed capital levels, the debate was another reminder of the government's stricter control over the industry.

The banks say the new rules could constrain them from lending and put them at a disadvantage to international competitors.



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