US earnings reports: Banks face greater risk or lower earnings
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US earnings reports: Banks face greater risk or lower earnings

US bank earnings beat forecasts; NIMs raise concerns about profitability

Declining net interest margins at US banks in the third quarter dampened what was otherwise a positive earnings season, as banks beat analysts’ mean earnings per share expectations.

At JPMorgan Chase, net income was $5.7 billion, up 15% on the second quarter in spite of a $6.2 billion trading loss, and up 34% on the third quarter of 2011.

Wells Fargo also reported record profits in the third quarter of 2012. Net income was $4.9 billion, up from $4.05 billion year on year, and up $325 million on the previous quarter.

Citi’s earnings were hit by the write-down from its exit of Morgan Stanley Smith Barney. Its net income was $468 million, down 84% on the second quarter and down 88% year on year. Excluding the loss on its brokerage unit, a one-time accounting charge and credit adjustments, the bank reported a profit of $3.27 billion, however, which tempered analysts’ sentiments.

Bank of America’s core earnings were better than expected although litigation expenses and accounting adjustments led to it reporting net income of just $340 million. Analysts had, however, been predicting a loss for the US’s largest bank.

The positive results for the universal banks in their retail and commercial franchises were driven primarily by mortgages. According to Barclays, median mortgage originations rose 6% over the quarter while origination fees jumped 19%. The CEOs of the universal banks each commented on how the housing market appeared to be returning.

Commercial and industrial loans also boosted bank revenues, and deposits were also up for the banks, totalling about $5.7 trillion for the US’s large-cap banks.

Disparity of NIMS widens Banks' average net interest margin

Lower NIMs

Although upticks in mortgages and commercial loans have taken the spotlight, beneath the impressive headline figures lurk concerns about net interest margins: the difference between what banks pay out on deposits and earn on loans. The average margin for the industry’s largest banks is 3.12% – now the lowest since the second quarter of 2009, according to SNL Financial.

According to Barclays research, the median banks’ net interest margin (NIM) was down four basis points in the third quarter – at the higher end of its forecast. "Lower reinvestment rates on assets (loans and securities), increased repayments (post QE3), intensified loan-pricing competition (particularly C&I and auto) and a fall-off in purchase accounting adjustments all weighed," said the report. Further compression is expected.

Erik Oja, analyst at S&P Capital IQ, sees an unusual disparity in the most recent quarter in the magnitude of changes in banks’ NIMs. "Normally, banks’ NIMs increase or decrease together, or in a band, according to changes in market interest rates. However, in the third quarter, we have seen that some banks have been able to maintain their NIMs, while other banks have seen relatively steep drops in their NIMs."

Glenn Schorr, financials analyst at Nomura
Glenn Schorr, financials analyst at Nomura

He suggests these differences stem from several balance-sheet items. "For example, whether or not high-cost CDs have matured, and whether or not the bank was able to roll over these CDs at a lower rate. Also, the type of investment securities a bank has. Mortgage-backed securities have been particularly susceptible to interest rate declines, due to the Fed’s recent QE3 mortgage bond-buying programme. Of course, loan yields are a primary driver of NIMs, and the composition of a bank’s loan book plays a large role in how resilient a bank’s NIM is to market rates. Another item has been the level of non-interest-bearing deposits from a bank’s commercial customers, and whether or not they have grown." JPMorgan’s NIM decreased by 4bp in the quarter, while Wells Fargo’s plummeted by 25bp. Bank of America’s NIM was up, although it was artificially low in the second quarter and Citi’s went up 5bp. The regional banks’ NIMs were mixed, with US Bank and M&T up, and PNC and Comerica dramatically down.

That NIMs in the majority of cases are falling puts the banks in a difficult position. They need to boost deposits to cross-sell to customers in other areas such as mortgages, but it is becoming more costly to accept those deposits. This could lead to higher fees or banks turning away customers. JPMorgan’s third-quarter earnings release cited "limited reinvestment opportunities" as one reason that net interest income was down at the bank. Indeed banks are keeping mortgages on their balance sheets to boost earnings – an unpopular move with analysts given the interest rate risk.

Glenn Schorr, financials analyst at Nomura, says some banks are faced with two options in the absence of loan growth – lower earnings, or taking on greater risk. Schorr says the compression is likely to continue and that it is not to be overlooked.

"Net income is the largest percentage of earnings, and net interest margins coming down is one of the biggest pressure point on revenues. Banks will have to take their pick whether to extend or stay neutral." Schorr adds that the pressure on NIMs in an uncertain economic environment might boost M&A. That will test regulators’ aversion to banks getting bigger.

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