Big banks expose a big divide between Main Street and Wall Street

07/17/2020 Business


This gap in the banking industry reflects the bifurcated rebound in the United States from the pandemic.

The stock market has largely recovered from the crisis and companies are raising record amounts of money in the capital markets. But the real economy is still in crisis. Millions of Americans are out of work, countless small businesses are on the verge of collapse, and corporate bankruptcies are on the rise.

“Time is the killer in this. The longer this pandemic lasts, the worse,” said Chris Marinac, banking analyst and director of research for Janney Montgomery Scott.

Bad Loan War Chest Powered by Another $ 31 Billion

Big banks are planning the worst by increasing the cushions against bad loans.
JPMorgan (JPM), Bank of America, Wells Fargo, Citi (C), PNC and United States Bancorp (USB) set aside a combined total of $ 31.1 billion in additional loan loss reserves during the second quarter. Although cautious, those moves dramatically slashed profits and reflected a sense that more trouble is looming in the real economy.

“Bankruptcies continue to increase. There is ongoing stress in the job market. This is not going to end any time soon,” said Constance Hunter, chief economist at KPMG.

Bank of America (BAC)For example, it reserves another $ 4 billion to protect itself against bad loans due to the “weaker economic outlook related to COVID-19.” Those credit losses caused a 52% drop in Bank of America’s earnings.
PNC (PNC) it increased its bad loan reserves by $ 2.5 billion, causing the superregional bank to record a loss based on continuing operations.

“We are still in the middle of the storm. Banks are focused on getting ahead,” said Marinac.

Low rates mean weak earnings

But it’s not just about the growing credit loss reserves affecting banks.

They are also being squeezed by the extremely low interest rates imposed by the Federal Reserve to soften the blow of the pandemic. Banks get much of their money with the difference between the interest charged on loans and the interest paid on deposits. Close to zero rates flatten that gap, known as net interest income.

That key bank profitability metric fell 4% quarter-over-quarter at JPMorgan and 11% at Bank of America.

Wells Fargo’s (WFC) Net interest income fell 13% because the bank is still under Fed sanctions for its countless consumer abuses. Those Fed sanctions limit the size of Wells Fargo’s balance sheet, making it impossible for the bank to offset the pressure of low rates by lending more.

Buy analysts are confident that big banks can weather the storm, at least for now. This is because they were forced after the Great Recession to accumulate loss-absorbing capital for the next crisis.

And a bright spot in the Main Street business is housing, which is being fueled by low mortgage rates and the desire of many city dwellers to go to the suburbs.

For example, US Bancorp’s mortgage banking revenues tripled during the second quarter of the previous year.

Gangbusters neighborhood for Wall Street banks

While banks’ Main Street businesses stumble for the most part, the industry side of Wall Street is booming.

Morgan Stanley’s revenue increased 30% in the second quarter to a record $ 13.4 billion. Goldman Sachs increased revenue by 41%, the second best quarterly performance in the bank’s history.

Both companies are thriving on increased business activity.

Morgan Stanley’s business and sales revenue increased 68% from a year earlier due to “high customer activity”. Commercial fixed income revenues nearly tripled to $ 3 billion thanks to “strong activity in global capital markets.”

Similarly, Goldman’s fixed income business income peaked at nine years, while its variable income unit generated the most income in 11 years.

“There was a lot of volatility, and that’s good for business,” said Marinac.

Goldman Sachs is crushing it as booming markets overcome Main Street turmoil

It is not just that people trade more.

The Federal Reserve’s emergency actions, including its unprecedented promise to buy junk bonds and other corporate debt, widened capital markets after essentially closing in March. American companies raised nearly $ 190 billion through the sale of shares during the second quarter, more than ever, according to Dealogic.
That kind of deal is music to the ears of Wall Street banks, who are paid to write IPOs and other stock and bond sales. Goldman Sachs (GS) reported record revenue from underwriting both debt and stock sales.
Of course, strong capital markets not only benefited Goldman and Morgan Stanley (em). They helped buffer the credit losses of the largest, most diversified banks. For example, JPMorgan’s investment and corporate bank reported an 85% profit jump in record revenue. Its commercial business also grew sharply, with a 99% increase in business income from fixed income. Without booming markets, JPMorgan’s earnings would have fallen much more.

However, analysts, and even bankers themselves, warn that the growing income of investment banking is unsustainable. Eventually these trends will flatten out.

Wall Street CEOs don’t trust V-shaped recovery

Bank executives, in stark contrast to the euphoria on Wall Street, gave a decidedly cautious tone this week.

Jennifer Piepszak, chief financial officer at JPMorgan, said the bank is prepared for double-digit unemployment until the first half of next year. The Fed, on the other hand, has been projecting unemployment to drop to 9.3% for the fourth quarter of this year.

“You will have a much murkier economic environment in the future than in May and June,” said JPMorgan CEO Jamie Dimon. “We are prepared for the worst case scenario. We just don’t know. I don’t think anyone knows.”

Wells Fargo chief Charlie Scharf simply said, “The economic recovery will not be easy.”

All of this suggests that the path ahead will be a challenge for large banks. Until the real economy recovers, banks will fight.

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