Enjoy it while it lasts: Bank earnings face trouble
Wall Street's blowout quarter for big bank earnings comes in the shadow of a daunting specter—An onslaught of potential Washington regulation that could put a major dent in profits.
Recent days have seen an increased likelihood that banks will have to carry even more capital on their balance sheets than originally thought, and some executives and analysts are worried.
(Read More: Trying to stop banks from destroying us)
JPMorgan Chase Chairman and CEO Jamie Dimon and other company officials warned of the looming regulatory crackdown during the company's earnings call Monday:
Marianne Lake, chief financial officer: "… we will take appropriate actions to reduce our leverage assets … for example, re-pricing or restructuring of commitments or unwinding certain derivative positions."
Dimon: "If you have a world where some businesses have to have twice as much capital as other companies, that over time can create huge competitive disadvantages. I don't know of any industry in America who would want to compete globally on that basis. We have an interest in a safe and sound system so we're not against a leverage ratio but we would be – we're not for a largely unbalanced competitive playing field. So put aside, that regulators know that. They're trying to – we thought that the point of Basel and all that is to harmonize these kind of things.
And if you ask about it, we show here, and Marianne just shows it, anything which is a low RWA asset (risk weighted asset), including HQLA (high quality liquid asset), revolvers, certain types of derivatives, those things obviously we will look at a little bit differently because there's leverage asset ratio. And we won't have to do it by business yet. We'll give you more detail later.
Like even Marianne had mentioned that we take huge deposits in from countries and from money funds, et cetera, that we may not take in because you can't afford capital against a deposit, $1B you get in from a money fund that you park at the Fed for 25 bps, you pay the FDIC 10 bps, you pay the client 5 or 6 or 7 bps and you've got to put 6% capital. against it. There are a whole bunch of things we've got to figure out how we're going to do it.
… If it's what we call a big wholesale short-term deposit, you're absolutely correct. We could probably restrict that over time." (Transcript courtesy of Dick Bove, vice president of equity research at Rafferty Capital Management.)
Dimon's comments came in the wake of fairly solid earnings. The company reported profit of $1.60 a share, a 31 percent increase and 16 cents ahead of the Wall Street view.
But it also warned that bond market troubles are likely to eat into profits and lead to cost-cutting ahead.
That could become a common refrain among JPMorgan's competitors on the Street.
"With the rise in interest rates, the tailwind for banks from the refinancing boom may soon fade," Bank of America Merrill Lynch analysts said in a note.
(Read More: No 'Whale' here: JPMorgan profit, revenue surge)
Net interest margins remain a concern for banks, and now they'll have to contend with an onslaught of new regulatory proposals, spearheaded by Sens. John McCain, R-Ariz.., and Elizabeth Warren, D-Mass.
Bove argues that attempts to shrink big Wall Street banks will endanger the industry by turning it over to the hands of smaller, less stable and less diversified institutions.
"By crippling the competitiveness of the U.S. banks and allowing foreign banks to take market share away from all U.S. banks, the regulators are attacking the base of U.S. bank profit. This is a direct attack on their safety and soundness," he said. "The regulators like the legislators backed by the media are driving U.S. banking to another crisis."
In the near term, though, investors have focused on robust second quarter earnings that are meeting and exceeding already-elevated expectations.
Goldman Sachs, for instance, doubled its profit. But that came against weak comparisons from 2012.
(Read More: Bank boom continues:Goldman Sachs profit doubles)
Sequentially, the results were less impressive.
Net investment banking revenues were flat compared to the first quarter, institutional client services revenue plunged 16 percent and total assets dropped by more than $20 billion, or 2.2 percent.
Consequently, Tuesday's earnings call focused as much on the regulatory capital environment going forward as it did on the past. And despite the top- and bottom-line earnings beats, Goldman's shares went negative in morning trading.
Bernstein Research praised the earnings report but warned that the bank now faces a critical handoff from a rate-driven to economy-driven cycle.
"A delay in investment banking could make the handoff between one point in the cycle and the other much more difficult," Bernstein analyst Brad Hintz said. "Cycle stocks can be hugely successful but only if the cycle is predictable and the handoff occurs perfectly."
Raferty Capital's Bove thinks that might not happen if the pressure on bank intensifies.
"At its core the safest and soundest banking companies are those that consistently generate a positive cash flow. They are able to do this if they have the freedom to compete globally on an even basis," he said. "Further, in banking we know that the diversified banks are safer and sounder than the monoline companies...The regulators are attacking both premises."
—By CNBC's Jeff Cox. Follow him
@JeffCoxCNBCcom on Twitter.