By Saabira Chaudhuri
Halfway through the year, banks aren't exactly hitting their
stride.
Despite growth in lending and near-record stock markets, the
biggest U.S. banks are expected to show second-quarter results that
continue to be hampered by low interest rates, slow trading
conditions and big legal bills.
Wells Fargo & Co. starts off the bank earnings season Friday
and is expected to show modest profit growth, according to analysts
polled by Thomson Reuters.
But overall, the six largest U.S. banks--Wells Fargo, J.P.
Morgan Chase & Co., Bank of America Corp., Citigroup Inc.,
Goldman Sachs Group Inc. and Morgan Stanley--are expected to show
quarterly revenue declined 5.6% from the previous year, according
to the analyst estimates. Profits are expected to fall 10.3%, to
$19 billion, as banks face a tough comparison with a strong second
quarter a year earlier.
"The environment clearly remains very difficult," said Chris
Kotowski, a banking analyst with Oppenheimer & Co. He sees
better times ahead when interest rates rise, but said the current
climate for banks feels like "slogging through a malarial coastal
swamp." Net interest margins, which measure the difference between
what a bank makes on lending and what it pays depositors, have been
squeezed as rates have stayed low. Indeed, large banks have been
stuck in neutral since last year, when the six firms had their
highest net income since 2006 and finished the year following five
consecutive quarters of profit and revenue growth. Both streaks
ended in the first quarter.
Some analysts said the slump may be temporary. Legal costs,
which will likely be an issue for Citigroup and Bank of America in
the latest quarter, could subside soon. Lending growth is
accelerating. And some of the downturn is explained not by
fundamental weakness, but by the expected absence of a significant
tailwind seen last year from big reductions in reserves set aside
for potential loan losses.
Still, trading desks, once a lifeblood for investment banks,
have experienced a slowdown that has hampered revenue and profit
growth. In the business of trading fixed-income investments like
bonds, as well as currencies and commodities, investors' reluctance
to trade has been compounded by other problems, including
regulations that make it harder for them to take risks and make
short-term profits.
"We frankly have no idea where the bottom is" in the
fixed-income trading business, said Mr. Kotowski. Some analysts
recently cut their earnings estimates on investment banks as far
out as 2016, citing what they say will be a prolonged slump in the
trading business.
More recently however, there have been a few rays of hope in
trading as client activity appears to have picked up in June.
"People who were saying at the beginning of the quarter that
fixed income was going to be off terribly, my guess is they'll
probably do better than they expected," said the head of one
investment bank. June trading volumes have looked better especially
in the rates business, said another banking executive.
In Europe, average daily electronic fixed-income brokering
volumes at ICAP sharply increased in June from levels in April and
May, while volumes on foreign-exchange trading platform EBS also
increased in June.
Other bank executives caution, however, that the June relief
might turn out to be short-lived. And it isn't clear if the pickup
will be significant or widespread enough to prevent the expected
trading declines in the second quarter forecast by banks, including
J.P. Morgan and Citigroup.
A slump in trading is expected to be mitigated by stronger
investment-banking revenue in the second quarter, with
mergers-and-acquisitions revenue showing robust growth from a year
earlier.
Meanwhile, loan growth is expected to have stayed strong in the
second quarter. Commercial and industrial lending is expected to
continue to increase, while consumer lending could also start
picking up. Analysts at Deutsche Bank recently noted that loans for
the largest 25 U.S. banks are up 2.2% as of the second quarter's
end from a year earlier. Mortgage banking is also expected to
rebound, though overall levels remain low compared with the
refinance boom that ended in the second half of last year.
One lever for banks to boost profits even as revenue stays
sluggish is cutting expenses. But analysts warn that much in that
area has already been done. And large additions to litigation
reserves in recent quarters have weighed on cost-cutting efforts of
some big banks.
For the second quarter, analysts expect Bank of America to add
between $1 billion and $4.6 billion in legal costs tied to a
potential settlement with the Justice Department. Separately,
Morgan Stanley analysts recently cut their earnings forecast for
Citigroup after The Wall Street Journal and other media reported
that Citigroup was near a $7 billion settlement with the Justice
Department over soured mortgages.
Eyk Henning and Matthew Turner contributed to this article.
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