M.EAST BANKER have been working hectically for six months. Traders handled record volumes in troubled markets. Her colleagues spent mountains of equity and debt as companies tried to weather the economic downturn by accumulating capital. Commercial bankers indulged struggling borrowers and were forced to write off the value of the loans as the likelihood of repayment decreased. As a result, investment banking revenues increased in the first half of the year and most commercial banks suffered losses as they formed provisions for bad loans. This resulted in low profits at Bank of America, Citigroup and JPMorgan Chase, the big hybrid banks. Goldman Sachs and Morgan Stanley, which are more focused on investment banking, made excellent profits. Wells Fargo, a largely commercial lender, was losing money.
Third quarter earnings reported by five of these banks on October 13th and 14th tell a different story (the sixth, Morgan Stanley, was due to report on October 15th The economist went to press). Investment bankers were still busy – trading sales rose around 20% from Q3 2019, and Goldman’s profits doubled year over year. However, the pace of activity has been leisurely compared to the second quarter when trading sales rose 60% over the same period in 2019.
Banks also believe they are now largely prepared for losses. In the first half of the year, the Big Five posted provisions for bad loans worth $ 60 billion. But those in the third quarter were thinner at just $ 6.5 billion and not far from those in the third quarter of 2019 (see chart). The inventory of bad debt allowances is $ 106 billion, which is approximately 2.8% of banks’ loan books. The distressed assets are creeping in but are still far from the levels that would wipe the provisions. Jennifer Piepszak, JPMorgan’s chief financial officer, said customers are “keeping up”.
As the dangers of higher provisions and the prey of market volatility became less dramatic, investors ‘attention turned to a more prosaic impact on profits: the banks’ net interest income, or the difference between the interest on loans and other assets and the interest paid on deposits and profits other funding. These were weighed down by Federal Reserve rate cuts and low long-term bond yields. The five major American banks posted net interest income of $ 44 billion for the third quarter, 13% less than the same period last year. Overall, lower interest income, quieter trading revenues and falling borrowing costs meant that earnings were lower than a year ago, but less pronounced than in the second quarter. Bank of America, Citigroup, and JPMorgan earnings were down 11% in the third quarter, compared with a 56% decline in the second quarter.
The question now is what banks will do with their earnings. Regulators, still affected by the 2007-09 global financial crisis, want well-cushioned shock absorbers. On September 30, the Fed announced that the 33 banks with assets of more than $ 100 billion would be banned from buying back shares in the fourth quarter. In contrast to Europe, dividend payments are permitted, but limited. As a result, many banks are accumulating capital. JPMorgan’s equity ratio increased to 13.0% from 12.3% in the third quarter last year. At Bank of America, the rate rose from 11.4% to 11.9%. That’s about $ 35 billion more than regulatory requirements, Paul Donofrio, chief financial officer, told analysts.
With buybacks from the table, bosses can either spend or save the money. Some squirt out. Bank of America said it invested in adding branches in the third quarter despite the pandemic. Others acquire new businesses. On October 8, Morgan Stanley announced that it would buy Eaton Vance, an asset manager, for $ 7 billion. It did so just days after buying E * Trade, an online trading platform.
The extra capital could also come in handy when the economy performs worse than even the dire scenarios that go into risk provisioning. Bank heads were cautiously optimistic that this would not be the case. But investors have their doubts. At the beginning of the year, banks’ share prices were still a third below their level. ■
This article appeared in the Finance & Economics section of the print edition under the heading “The Calm After the Storm”.