Banking Industry Showing Signs of a Recovery

17th April, 2009

Just three short months ago, many of the nation’s biggest banks were on life support.

Now, a number are showing glimpses of a recovery, aided by a tentative improvement in some corners of the economy and new business picked up from rivals that stumbled in the wake of the financial crisis.

On Thursday, JPMorgan Chase became the latest bank, after Goldman Sachs and Wells Fargo, to announce blockbuster profits in the first quarter. The reports fed a rally in financial stocks that began more than five weeks ago, when Citigroup and Bank of America, two of the banks hit hardest by the crisis, suggested the worst might already be over.

Banks are enjoying a fresh wave of profits from the government’s efforts to nurse the industry back to life. Ultralow interest rates have led flocks of consumers to seek deals on mortgage loans. Investment banking and trading activities are enjoying a bounce from the billions of dollars spent to thaw frozen credit markets. And even before the results of a new health test for the nation’s 19 largest banks are unveiled, those who can flaunt an improvement from their dismal recent performance are quickly trying to free themselves from government money.

But this silver cloud has a dark lining: millions of consumers continue to default on their mortgages, home equity and credit card loans. Corporate loan losses are just starting to pile up. And the residential housing crisis is seeping into commercial real estate with a vengeance: on Thursday, General Growth Properties, one of the nation’s largest mall operators, filed for bankruptcy in one of the biggest such collapses in United States history.

“We are in the eye of the storm,” Gerard Cassidy, a banking analyst at RBC Capital Markets. “The worst is behind us for housing. For commercial real estate and corporate lending, there is still a big dark cloud.”

JPMorgan Chase reported a $2.1 billion profit in the first quarter, besting analysts’ average forecasts. Revenue increased to $25 billion, up 45 percent from $16.9 billion in the period last year.

Still, the results reflected continued turmoil in sectors like credit card services and private equity, businesses that reported losses or steep drops in revenue, reflecting the lingering effects of the recession on consumer spending and the credit markets.

Many banks are preparing for the next rainy stretch, setting aside more money now to cover future loan losses. Regional and community lenders, which are particularly exposed to corporate and real estate loan defaults, are socking away tens of millions of dollars to add to their reserves; big banks like JPMorgan are adding billions. “Times aren’t exactly great as we speak,” Michael J. Cavanagh, the bank’s finance chief, said in a brief interview. “Until home prices stabilize and unemployment peaks, we will continue to be under pressure for losses on our balance sheet.”

As long as interest rates remain low, and the government continues to offer financial support, banks hope to earn enough profit to cushion the blow of some of these looming losses.

The question remains whether the profitability is sustainable if the recession worsens.

Some experts are saying fears of nationalization and bank solvency are subsiding. “What we are recognizing now is that they can produce profits,” Charles Peabody, a financial services analyst at Portales Partners. “The next debate is on the sustainability of those profits.”

With good reason: the banking industry has gotten relief from recent changes to accounting rules, which could inflate earnings.

What’s more, a brief moratorium on home foreclosures during the winter will postpone when some banks book losses on a big swath of soured loans.At the same time, banks have benefited from unusually good trading results and low interest rates, which have propped up the value of their mortgage investments.

The official stress test findings, expected to be released on May 4, may help investors sort out the handful of banks that can generate enough earnings to absorb their losses if the economy worsens. Their conclusions may bear little resemblance to banks’ first-quarter results because the stress test is taking a forward-looking view of the banks’ conditions over the next two years. Quarterly earnings reports, by their nature, look back.

Officials involved in the stress test say they expect the results to show that some banks will need to raise fresh capital. A senior administration official emphasized, however, that those banks would not necessarily need new government money. Besides tapping private investors, banks could derive a major source of capital by converting the preferred stock now held by the government into common shares, as Citigroup intends. The Treasury is likely to rely on individual banks to release their results, and officials said they expected banks that need more capital to immediately announce plans for raising it.

But even ahead of the stress test, investors already appear to be rendering verdicts on which banks will emerge as survivors. Goldman Sachs shares are around $121. Citigroup shares, which fell below $1 in March, are trading at just over $4; Bank of America’s shares have rebounded to above $10.

On Tuesday, Goldman Sachs raised $5 billion of fresh capital in anticipation of repaying the government’s investment.

Jamie Dimon, JPMorgan’s chairman and chief executive, was adamant on Thursday that his company would pay back $25 billion as soon as regulators allowed. “Folks, it has become a scarlet letter,” said Mr. Dimon, referring to the taxpayer infusion the bank received in October. “We could pay it back tomorrow,” he said. “We have the money.”

Mr. Dimon added that his bank did not plan to be a buyer or seller in the Treasury’s public-private partnership program to siphon loss-making investments from banks’ books. “We’re certainly not going to borrow from the federal government because we’ve learned our lesson about that," Mr. Dimon said.