Bank Profits: Enjoy Them Now, They May Soon Be Scarce
The first quarter 2009 earnings of the major banks (JPMorgan, Citigroup, Bank of America, and Wells Fargo) were better than Wall Street expected, and the financial stocks, while volatile, continue to lead the stock market higher. But the details of 1Q 2009 tell us that the higher profits were not from their traditional lending business. Credit losses were very high, and with unemployment rising, they're expected to get worse, leading some observers to conclude that banks won't be able to keep up the strong first quarter pace.
There's a lot of detail in each of these companies' reports, but there are three issues in common that make the earnings look doubtful:
- Gains from accounting rules: Banks were able to recognize billions in profit from simply by following the proper accounting rules -- booking gains on transitory decreases in the value of their own debt, for example. These gambits are covered in detail by the New York Times, summarized nicely by the Financial Times' Alphaville blog and by my colleagues over at BNET Finance. (The FT reckons that about half of the total $12 billion in quarterly profits -- including Goldman Sachs -- were accounting rather than banking related.) The FT's Tony Jackson also weighed in: "On the face of it, this is a brilliant and unloseable game. Should any of those banks go under, their last act would be to post gargantuan profits as their bond prices plunged to zero."
- Trading gains: The banks also made lots of money from their trading activities. Those profits are genuine, but unusually high because the markets are still quite volatile. The trading profits may not be sustainable.
- Credit provisions: Delinquencies are rising rapidly on home mortgages and credit cards. On prime home mortgages, JPMorgan reports that between six and seven percent of its portfolio is 30 days or more past due -- double the level of September 2008 -- indicating future credit losses.
Are the banks back in their basic business of lending money? These results are mixed as well. Lending to businesses was up seven percent from year end 2008 at BofA, but flat at JPMorgan, and down at Wells Fargo. BofA has also been active in home-mortgage lending. Consumer lending is down a little at all the banks, but that's probably because people aren't spending as much.
Today's interest rates are low, but getting a mortgage is cumbersome because banks are asking for more documentation, and if you're out of work, you probably won't get a loan. Condominium loans are particularly scarce. Banks are getting tougher on credit cards, too, says my colleague Charles Wallace.
Although the stock market seems to like the results -- the financials are up 17 percent since the end of March, versus eight percent for the S&P 500 -- the warm feelings are not unanimous. A veteran analyst told me that he interpreted Bank of America's earnings as solid, but didn't think Citigroup would be able sustain its first quarter pace (actually, a smaller-than expected loss). Bank analyst-of-the-moment Meredith Whitney is even more skeptical, and expects losses later in the year. Last, the bond market's view of banks slipped after the earnings release - the cost of insuring bank bonds against default is higher by about 10 percent.
Chart source: Citigroup 1Q 2009 earnings presentation