Prospects Brighten for Big Bank Earnings

After a rough beginning to 2016, the top banks face improving conditions: calmer markets, Fed rate hikes and moderate growth.

Charlotte, North Carolina - August, 2014: View Of The Newly Reno

CHARLOTTE NORTH CAROLINA - August 2014: View of the newly renovated Bank of America Stadium home of the Carolina Panthers NFL football team

The rest of 2016 looks somewhat rosier for the big six U.S. banks, as the economy continues its gradual growth path and the Federal Reserve continues its gradual interest rate increases, analysts say.

The six institutions are Bank of America, JPMorgan Chase & Co., Citigroup, Wells Fargo, Goldman Sachs Group and Morgan Stanley. In the first quarter, earnings in their capital markets units suffered, and increased lending wasn’t enough to stop profits from dropping. But going forward, a benign economy should boost lending, calmer financial markets should boost capital markets activities, and higher short-term interest rates should boost net interest income, analysts say. Bank earnings won’t set the world on fire, but they should improve.

“If the Fed doesn’t have to stay on hold much longer, continuing with even just one or two hikes this year, that would support net interest margins,” says Guy Moszkowski, director of research at Autonomous Research in New York.

As for the economy, significant job gains and small wage gains point to a moderate expansion, says Richard Bove, a veteran bank analyst at New York’s Rafferty Capital Markets. “Growth of 1.5 to 2 percent is likely, and that’s all banks need for positive earnings growth.”

In capital markets, which include stock and bond trading as well as investment banking, revenues slid 5 to 25 percent for the big banks. Investment banking fees fell about 25 percent for most of the banks, as volatile financial markets curbed stock offerings, bond offerings and mergers and acquisitions activity. Market volatility also bit into trading revenue.

But there were disparities in fixed-income and equity-trading revenue. On the equity side, JPMorgan’s trading revenue dipped only about 5 percent, and Morgan Stanley’s 10 percent, less than their competitors. On the fixed-income side, which includes foreign exchange, Goldman and Morgan Stanley fared worse than the universal banks, with revenue down about 50 percent for the former and 15 percent for the latter.

The disparity likely stems from the fact that the universal banks serve the currency needs of fund managers and corporations, whereas the investment banks focus more exclusively on fund managers, particularly hedge funds, which reduced their currency activity because of financial market turmoil, Moszkowski says. “There was a fair amount of deleveraging for hedge funds, and that had a disproportionate impact on Goldman Sachs and Morgan Stanley.”

The results were distressing for banks, as the first quarter is usually their best for trading and sales. But David Hilder, senior equity analyst at New York brokerage firm Drexel Hamilton Investment Partners, says banks will likely see a rebound in capital markets revenue this quarter.

The market panic of January and February is over, at least for now, he notes. “Stocks are up, which opens the door for IPOs. The environment for corporate M&A is getting better. And credit spreads have tightened, so it’s more attractive for corporations to issue debt.” Investment banking fees could accelerate through the second half of the year, Hilder says. Already, banks have reported that their capital markets performance improved at the end of the first quarter.

When it comes to lending, the news was good for the first quarter. Commercial and industrial loans soared 23 percent for the 25 largest banks, although Hilder cautions that this segment can be volatile, and some of the gain may have stemmed from troubled energy companies drawing down their credit lines. Real estate loans climbed 12 percent.

The strong loan demand, combined with the Fed’s December rate hike, provided a boost for banks’ net interest margins. That increase represents a positive surprise after two years of brutal contraction, Moszkowski says.

Moderate economic growth should continue to buoy loan demand going forward, analysts agree. Losses on oil loans weren’t as bad as expected in the first quarter. “There was panic that oil would be like real estate in 2008,” Bove says. “Now that the numbers are out, it’s evident that you can control losses from the energy sector.” It’s likely that banks will be able to reduce their reserves for energy loan losses this year, he says.

Banks will continue to be hindered by increased regulation, Bove says. “The banking industry has effectively been nationalized, with the government telling banks how big they can be and what assets they can have.” About 200,000 people are probably working for the government and banks to make sure they’re in compliance with the rules, he says, adding, “That’s not capitalism.”

Still, he agrees with others that economic growth will help banks in coming months. “Bank earnings are purely a function of where the economy is going.”

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