Banks Gaining a Foothold in the Still-Fragile Economy

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The New York Times
By: Eric Dash
April 12, 2011

Just two years after the financial panic reached its nadir, the nation's biggest banks have regained their footing.

Loan losses are easing and all the large banks have returned to profitability. Lending is slowly picking up. Even dividend increases have resumed at some institutions. Over all, the industry's first-quarter earnings are expected to rise about 2.4 percent from a year ago, when banks begin announcing results this week, according to analyst estimates compiled by Thomson Reuters.

That is the good news. But for all the signs that the financial sector is back, formidable challenges remain.

Investors will get their best glimpse yet of the new financial landscape -- known as the New Normal in banker-speak -- when JPMorgan Chase begins the earnings season on Wednesday. Much of the attention is likely to focus on the ability of banks to increase revenue amid many tough new regulations, volatile markets and a still-fragile economy where housing prices have yet to rebound.

These trends, analysts say, could further divide the industry between the weak and the strong, as banks with more diversified businesses and lower operating costs gradually pull ahead of the pack.

"There are going to be the haves and have-nots," said Paul Miller, a banking analyst at FBR Capital Markets. "Revenue pressures will be across the board so the winners will be those who run their banks more efficiently."

JPMorgan Chase and Well Fargo, for example, are both expected to report strong per share profits for the first quarter. Analysts are predicting that those two institutions will have to set aside less money to cover future losses, and perhaps even reverse earlier provisions for losses, increasing their earnings.

Citigroup and Bank of America, which have been much slower to recover from the financial crisis, are expected to report a decrease in earnings per share from a year ago. Wall Street firms, like Goldman Sachs and Morgan Stanley, could also see a falloff in profit amid weaker trading and investment banking results.

All the while, revenue is expected to drop considerably. Goldman Sachs, Morgan Stanley and Citigroup are expected to have revenues fall sharply from the first quarter of 2010, when unusually strong trading helped prop up their earnings. JPMorgan and Wells Fargo could also experience a falloff in revenue as new rules limit their ability to generate income from overdraft fees and other banking fees.

The New Normal will be taxing for even the best-managed lenders. But the biggest questions surround the mortgage business and the weak housing sector, which continues to impede the industry's recovery.

Banks are still reckoning with the fallout from the foreclosure debacle, when sloppy documentation practices and inadequate staffing to cope with the deluge of troubled home loans created an enormous mess.

Federal regulators are expected to order the banks to make sweeping changes to their mortgage collection and foreclosure practices, which will sharply drive up expenses. Meanwhile, banks continue to shift billions of dollars into reserves to cover possible penalties by the state attorneys general as well as the cost of resolving several immense private investor lawsuits.

Business issues loom, too. Mortgage originations were down about 30 percent in the first quarter after the refinancing boom during the third and fourth quarters of 2010, when interest rates were near record lows.

With rates widely expected to climb higher, even normally bullish home builders are bracing for a dismal spring. And there is no sign that housing prices have bottomed out.

In fact, as the backlog of foreclosed properties piles up, some analysts expect that the banks will be forced to book billions of dollars in additional losses in the coming months if prices continue to dip.

"It's setting up to be a pretty weak spring housing market," said Frederick Cannon, a veteran banking analyst at Keefe, Bruyette & Woods in New York. "We could get a scare in the second quarter in terms of the value of foreclosed properties on the banks' balance sheets."

New regulations, especially those governing derivatives and debit card fees, are also expected to take a big bite out of revenue in the first quarter. What is more, many banks have increased spending on new computer systems and added more compliance workers as they have moved to adapt their businesses to the new rules.

Meanwhile, the Wall Street operations that have fueled the revenues of the biggest banks over the last few years are starting to flatten out. On average, investment banking fees could drop 10 to 15 percent from the previous quarter, although some banks may record outsize gains from big deals. JPMorgan, for example, helped advise and arrange financing for AT&T's planned $39 billion acquisition of T-Mobile, among several other large transactions.

Trading revenue remains a wild card. A year ago, the four biggest Wall Street banks had an unusually strong first quarter, when there was not a single day during the period in which they posted a trading loss.

During the first three months of 2011, the only consistent thing was a lack of consistency, with fears over the nuclear disaster in Japan, uprisings in the Middle East and lingering concerns about sovereign debt in Europe and even in the United States all weighing on the markets.

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