Profits at banks and Wall Street firms likely rebounded in the third quarter. Analysts are expecting that operating profits at nearly all the large banks and Wall Street firms will be up from the prior quarter and a year ago.
That’s a change from the second quarter when the profit picture was mixed. Even ignoring JPMorgan’s whole London Whale debacle, earnings were held down by a lack of deals, weak trading volume and a stagnant housing market. What’s more, loans, the main source of revenue for banks, either because financial firms didn’t want to lend or because borrowers were still nervous about the economy, were not increasing. Throw in all the reforms, and that left some worrying banks could no longer grow. A number of firms announced layoffs.
All those things appear to be changing. While Wall Street remains slow, deal making made a comeback in September. In fact, it’s likely that equity underwriting, that is selling shares of stock for public companies like AIG, which did a big offering recently, had its strongest month of the year.
Commercial and industrial lending appears to be growing much faster than usual – a good sign for the economy. And, at least for now, banks appear to be getting an added boost from Ben Bernanke and QE3. But the best news is that housing prices are rising again. That, along with lower mortgage rates, should translate into fewer foreclosures, which remain one of the biggest drags on bank profits.
Analysts expect operating earnings at Bank of America (BAC) and Citigroup (C) will be up 16% and 20% from the prior three months. Earnings per share at Goldman Sachs (GS) could also be up 20% from the second quarter.
“Banks are not hurting,” says Dick Bove, an analyst at Rochdale Securities. “They are making a shitload of money.”
Some question how long that will continue. The biggest wild card is the Federal Reserve’s recently announced plans to buy mortgage bonds indefinitely. For now, that’s been a bonanza. Mortgage bond rates, which is essentially what the banks have to pay to fund, these days from the government, home loans, have dropped much faster than actual mortgage rates, which is what consumers actually have to pay. That’s opened up a huge spread between those two rates. It’s nearly three times as large as usual, which essentially means banks are making nearly three times as much.
“Mortgage spreads are 80 basis points larger than there were just a few months ago,” says Bove. “That’s just pure profit.”
Eventually, though, some worry that the Fed’s relentless efforts to drive down interest rates, particularly if it lasts another year or so, will hurt the banks. Inflated mortgage rates are likely to be only temporary. More long-term is the fact that banks are going to be left with loans that are at substantially lower interest rates than the loans they made a few years ago.
What’s more, while Wall Street firms are technically still allowed to do proprietary trading, that is making risky bets with their own money, at least for another year or so, Brad Hintz, an analyst at Sanford Bernstein, says it doesn’t appear that many are. Instead, he said the firms are getting ready for a time when the regulations will likely significantly restrict what they can do with their money. That’s held down trading profits. What’s more, Hintz says the firms still aren’t completely sure how much capital they need on hand to meet new requirements. That’s made them gun shy with trading and lending as well.
“You are still going to hear plenty about expense controls,” says Hintz. “It’s not going to be a good story for those of us who rely on bonuses.”