Underwhelming results from some big U.S. financial institutions, including a quarterly loss from Goldman Sachs Group Inc., (GS-N101.070.210.21%) have raised fresh questions about the health of the country’s financial sector.Beyond the headlines, however, key fundamentals are improving. While institutions with the greatest exposure to Wall Street trading are showing disappointing numbers, banks that are in the bread-and-butter business of taking deposits and making loans slowly continue to clean up their balance sheets, fuelling hope for an eventual U.S. economic rebound.
Analysts say those looking for signs of another crisis in the U.S. financial industry are coming up short. Instead, the banking sector is muddling through another quarter, gradually pulling itself out of its funk.
“The U.S. economy in the third quarter did a little bit worse than expected because of a sharp drop in consumer activity and confidence,” said Erik Oja, who follows big U.S. banks for Standard & Poor’s. “But looking into the different components, commercial credit is doing very well, with mid-market and small businesses borrowing and expanding.”
Goldman Sachs surprised markets on Tuesday, reporting only its second quarterly loss since going public in 1999. Much of those losses, however, came from the company writing down the value of its investments – a reminder that despite its status as a bank holding company, Goldman Sachs is not representative of the banking sector.
“Goldman Sachs is not a bank, it’s an investment bank” says Robert Wessel, a fund manager at Hamilton Capital in Toronto. “To most investors, if you take deposits and make loans, you are a bank. Goldman Sachs is a broker-dealer, and does not make loans.”
The four major banking companies that have reported since last Thursday – JPMorgan Chase & Co., Wells Fargo & Co., Bank of America Corp. and Citigroup Inc. – all have varying amounts of exposure to capital markets through investment banking or trading operations. And, for the most part, those operations were a drag on performance, reflecting a rough quarter for the stock market.
In addition, all the banks reported a decline in net interest margin – the spread between the rate a bank pays for deposits or borrowings and the yield it gets on its loans and investments.
“Declining interest rates and intense competition for commercial loans are problems for all banks,” says Paul Miller of FBR Capital Markets. He says banks have two choices: refuse to make loans at lower rates and watch assets – and profit levels — fall, or try to defend their aggregate amount of profits by continuing to lend at lower yields.
These factors will likely continue to weigh on earnings, but analysts see no evidence in the recent bank results of deteriorating credit quality or more fundamental issues.
At Wells Fargo, the percentage of bad loans, or “non-performing” assets, has dropped to 2.2 per cent of the balance sheet in the third quarter, down from 3.09 per cent a year earlier. It was the fourth consecutive quarterly improvement. At Citigroup, which is busily divesting a mound of troubled assets, the figure has dropped to 5.16 per cent from 7.16 per cent.
At JPMorgan, bank management created an earnings disappointment by “releasing” much less of its loan reserve than expected. Each quarter, banks cut into earnings by making provisions for bad loans, creating reserves for the time the loans must be charged off. As credit conditions improve, banks can make smaller provisions and let their reserves shrink.
FBR Capital’s Mr. Miller had expected this manoeuvre to add $1.15-billion (U.S.) to JPMorgan’s profits this quarter; the bank added just $150-million by provisioning more than expected. The decision has been viewed as an indication of JPMorgan’s conservatism, since the other major banks didn’t replicate JPMorgan’s move.
Indeed, asset quality improved at all four banks, says S&P’s Mr. Oja. “Credit quality is improving, but the pace of improvements is fairly slow.”
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Source: Globe&Mail
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