U.S. Fourth Quarter Bank Earnings: Thankfully Not The New Normal

U.S. bank earnings for the full year and fourth quarter of 2011 reflected all that was good about the US economy, all that was bad about the global capital markets, and much that was punitive about the regulatory arena. Loan quality improved and nascent growth could be detected, but trading revenues were down, and banks staggered under $35 billion of legal charges related to mortgage loans sold and the loss of about $7 billion in revenues due to regulatory changes. As the year ended, major questions about how those three issues would be resolved still hung in the air, and promise to bedevil 2012 as well. All that leads analysts to ask, what of what we saw in 2011 will be the new normal? I believe that that is too pessimistic a view.

Core Net Income*
	4Q2011	3Q2011	2Q2011	1Q2011	2011	2010
Bank of America	(590)	(1,188)	(7,406)	2,155	(7,333)	9,832
Citigroup	2,024	2,629	2,988	3,565	11,148	11,893
Goldman Sachs	738	170	1,236	2,686	5,202	8,909
JPMorgan	4,336	3,363	5,367	5,443	18,486	19,642
Morgan Stanley	311	127	1,013	667	2,392	3,909
PNC	765	830	913	837	3,495	2,965
US Bancorp	1,143	1,273	1,203	1,046	4,665	3,317
Wells Fargo	4,324	4,623	4,584	4,413	17,943	15,464
Total	52,199	47,302	39,588	83,248	55,999	75,930

*excludes gains on sale, other non-recurring items, and gains/losses on own debt but includes mortgage-related special charges

The good news

Tentative US economic growth manifested itself in a pick-up in commercial lending activity for small and medium sized businesses in the second half of the year. Syndicated lending activity was strong as well, and US banks profited from the retreat of European counterparts to pick up business there. As a result, commercial loans grew 5.5% for the year.

Loan losses except for first and second residential mortgages are now at or better than normal levels for a stable economy. Lower loan losses, as well as reserve reversals, have allowed provisions to fall by two-thirds from 2009. The corporate sector is healthy. Credit card portfolios have been cleaned out of the weaker borrowers, so that card charge-off rates are only about 4.5%, a level not seen for about 15 years. Provisions remained below the level of charge-offs during the year but crept upwards to finish at 92% by the first quarter. Reserves were therefore depleted as a percentage of loans but not in terms of their coverage of annual losses. Provision expenses will likely level out in 2012 as loss rates edge down slightly but reserve reversals diminish.

By 2013, provisions could start to climb again. Much will depend on the pace of mortgage losses however. They remain at very elevated levels; even though some barely perceptible improvement in loss rates was visible in 2011, once foreclosures resume, they could rise again, and take a few years to work through.

Based on these trends, the traditional commercial banks, especially those that were not large mortgage lenders, were solidly on the come-back trail. Persistent low interest rates are the remaining obstacle to achieving normalized profits. Net interest margins have been in steady decline for three years, but appeared to stabilize, or even rise a few basis points in the fourth quarter versus the third.

A stronger economy with rising rates would boost margins because of the vast amount of "free funds" (e.g. checking deposits, common equity) on bank balance sheets that could then earn higher interest.

Investment banking reflects volatile and uncertain capital markets

For the largest six banks, all of whom have investment banking or mortgage operations, or both, the story is more troubling. Deep uncertainty about whether a disorderly unwinding of the European Union or some of its members could precipitate another financial meltdown sidelined many participants. Client revenues in trading fell 20% for the year, especially in the second half: