Big U.S. banks worked hard to cut costs and maintain profits during the second quarter, and several managed to beat expectations. But there is no avoiding the elephant in the room: The current low rate environment and macroeconomic concerns are hurting banks’ revenue prospects.
Five of America’s six biggest banks have reported earnings so far, and four of them saw their net interest margin shrink from the end of the first quarter. That’s the difference between the rate they lend or invest at and the rate they pay to borrow. The one with the best net interest margin, Wells Fargo, saw it hold steady during the quarter.
Look at this chart to see how little the biggest universal banks are making on their loans and other interest bearing investments:
“It’s an issue for everyone,” said Richard Ramsden, financials analyst at Goldman Sachs, noting that a bank’s securities portfolio would currently yield around 3 percent, with reinvestments generating less than that. “Assuming a bank has to reinvest a quarter of its securities portfolio, that’s a problem.”
Low interest rates are a big reason why the big banks generally disappointed analysts on their second quarter revenue. That, despite good news on making new mortgage loans from Citi,BofA,Wells Fargo and JPMorgan. But as Citigroup CFO John Gerspach pointed out, the mortgage boom might last through next quarter, or even the end of the year, but it won’t go on forever. Gerspach pointed to the more pessimistic macroeconomic outlook Fed Chairman Ben Bernanke gave to Congress this week as a reason to expect the trend to end.
“Unless you know something I don’t know, I don’t see long term rates going up for the next one to two years,” Citi CEO Vikram Pandit said when asked when interest rates would recover.
That’s why this quarter was all about cost cuts. Goldman Sachs CFO David Viniar said the only way to boost return on equity in this environment was through expense control and share buybacks.
At Bank of America, management announced that cost cuts were ahead of schedule. The bank also said it would cut costs by an additional $3 billion a year by 2015. “We're fighting the trend, a trend that's gone on longer than people have expected,” CEO Brian Moynihan said of his depressed net interest margin. “But we're fighting it with all the arrows in the quiver that we have.”
The bad news on interest rates was compounded by the bad news in sales and trading businesses at the largest banks. While they generally were better than expected, trading and underwriting revenue fell from the first quarter as fears about Europe and the fiscal morass in the U.S. put clients firmly on the sidelines.
The bankers themselves are concerned about Europe. Goldman Sachs had the lowest value at risk — a measure of a firm’s daily risk exposure since the third quarter of 2006. JPMorgan's Jamie Dimon reiterated that his firm is doing business in the weakest European economies because clients needed the services. He added that the bank was doing it “more carefully, and hedging exposures there.”
That fear will also show up in Morgan Stanley’s earnings on Thursday, according to research by Jeff Harte, analyst at Sandler O’Neill. Morgan Stanley will also have to continue to show its exposure to Europe is under control.
Small wonder returns on equity were disappointing:
Although Dimon gets credit for achieving that ROE while swallowing a $4.4 billion second quarter loss from the London Whale, even he acknowledged that if the interest rate environment doesn’t change, JPMorgan’s earnings will be stagnant.
Going forward, analysts are concerned that fallout from the problems in Europe and a weakening U.S. economy will hurt returns at even the best performer, Wells Fargo. Between fear of the capital markets and slipping interest margins, there just doesn’t seem to be a way for banks to turn a buck.