Wall Street banks face growth quandary

Christmas lights illuminate the New York Stock Exchange in the heart of Wall Street Credit: Flickr user Zoonabar

COMMENTARY: With big U.S. banks set this week to announce earnings for the final quarter of 2011, the outlook on Wall Street for the new year is already in. The verdict? Fun's over.

Since taxpayers bailed out these lenders following the housing crash, the companies have shown strong earnings growth. Two factors propelled that recovery -- favorable accounting rules that allow banks to dress up their results, and a reduction in the financial reserves they must set aside to offset souring loans.

But those days are winding down, as is evident in JPMorgan Chase's (JPM) shrinking profits, slumping investment banking business and continuing hangover from the housing crash. The picture is equally murky at retail giants Bank of America (BAC) and Citigroup (C), while things could get downright ugly for investment banks Goldman Sachs (GS) and Morgan Stanley (MS). Only Wells Fargo (WFC) is expected to report a healthy rise in profits.

A caveat -- such predictions may not mean much. As bank analyst Chris Whalen of Institutional Risk Analytics notes, even top banking executives don't have a clear idea of what 2012 will bring. There are too many unknowns, notably whether the "green shoots" recently poking up through the wintry U.S. economy can bloom into a full-blown recovery and whether Europe can avoid disaster.

Along with such uncertainties, a key question looms over all of the nation's large banks: How will they grow? After all, top-line growth is unlikely to be driven by trading, advising on mergers and acquisitions, and other investment banking activities. New federal regulations, such as rules for credit cards, also make it harder for companies to stick customers with additional fees. And the main lever of growth for banks -- the interest they collect on loans -- is under pressure from low interest rates, while loan demand remains muted.

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Another likely damper on bank earnings, according to a recent report from financial data provider Trepp:

[T]he loss reductions that gave a great lift to bank earnings over the last eight quarters have now run their course. Without the impact of reduced loss provisioning, bank earnings growth will have to come from other areas.

Unfortunately, we do not see any of the other large contributors to earnings growing sufficiently to move the needle in a positive direction.

That's a big deal for banks. Large institutions, in particular, have masked their difficulties over the last two years by strategically "releasing" such loss reserves across their balance sheets as the credit environment slowly improved and fewer loans went bad. Those reserves accounted for roughly a third of banks' net incomes last year, notes Trepp, which expects industry profits to fall 7 percent in 2012, to $117 billion. Meanwhile, declining earnings also likely means more layoffs, as pressure grows on banks to cut costs.

With their other business lines sagging, banks' fortunes are increasingly dependent on lending. Indeed, the income commercial players earn from loans now far outpaces what they make on trading, underwriting securities or collecting service fees. But that, too, spells trouble because interest income from loans and leases is decreasing. With the economy struggling to get out of low gear, in other words, banks' core business is slowing down.

The upshot: Whatever the latest quarterly results show for Wall Street, they are likely to be as good it gets for quite a while.

  • Alain Sherter On Twitter»

    Alain Sherter is an award-winning business journalist who has written for The Deal, MarketWatch and Thomson Financial Media.

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