Richard X. Bove, Vice President Equity Research (Financial Sector), Rafferty Capital Markets, LLC paints a somber future for banks in his analysis “The Momentum is Gone – Banks Must Earn Their Profits” of October 23, 2013.

Banks

The analysis, covering five quarters of data across a selection of universal banks, trust banks, regional banks and investment banks, makes the key point that the conditions that allowed banks to report improving operating results (y-on-y) for 16 quarters no longer exist. Henceforth profits will need to be generated out of the ‘knitting’ so to speak – lending money at better margins.

But this is possible only if the economy grows, and additionally, if the banks are not continually bludgeoned by regulatory clubs such as governmental lawsuits and penalties.

Key trends

  • Assets continue to expand but cash balances are growing disproportionately. Regulatory pressures are compelling banks to keep money with the Fed – at last count $2.25T – which, according to Bove, is 2,000 times over normal.
  • Reserves unwinding could reach rock bottom, and banks are soon going to be unable to tap this useful source of augmenting earnings growth. Excessive reserves built up during the crisis have been systematically dismantled but we may soon reach the bottom of the barrel.
  • Total deposits are growing exponentially, but banks are unable to find avenues to lend out the money. As a result the funds are getting deposited with the Fed.
  • Though loan growth is visible in construction lending, commercial RE, and the auto sector it is still sluggish in the commercial and industrial arena. This is because business is still hesitant to take the plunge into new projects.

The transition to lending

Though interest margins are gradually recovering, the real boost could only come from switching Fed deposits to loans, which is not happening, as discussed above.

Advisory, underwriting and trading incomes have shown poor growth in recent quarters. Mortgage origination fees, particularly on refinancing, have dried up after the recent rally in interest rates. The analyst expects capital market activity to rebound only in Q1 of 2014. Mortgage banking is expected to be slow for at least two quarters.

After 16 quarters we are likely to see the first one with a y-on-y decline. Banks now desperately need the tailwinds from a growing economy to help them boost lending and augment real incomes from real lending. Reserve write-backs and diminishing loan provisions (when no loan growth exists) that boost the bottom line are crutches the banks would like to do without.

Banks stock prices

Banks stocks have overshot the equity averages, but according to the author, “this outperformance reflects the flow of funds into equities rather than fundamental performance. Bank stock prices are being driven by sentiment and valuation and not earnings. This is very dangerous.”

Here are a few key figures, covering only universal banks, from the impressive data appended in the report.

YOY Change% Bank of America Citigroup JP Morgan Chase Wells Fargo
Assets 1.8 1.6 6.1 8.2
Cash/Cashlike -2.4 -0.5 32.7 71.1
Tot Securities -5.1 -2.5 -8.8 9.3
Loans 4.6 -0.1 1.2 3.8
Reserves -25.9 -20.5 -23.0 -12.8
Reserves/Loans -29.2 -20.4 -24 -16
Demand Deposits 3.3 -0.7 10.8 4.1
Intt Bearing Deposits 5.0 1.6 13.2 11.5
Total Deposits 4.4 1.1 12.4 9.4
Common Equity -0.4 4.9 2.6 6.6
Tangible Common Equity -1.0 5.8 4.0 14.4
Tier 1 Common Ratio 10.8 20.9 10.7 19.0
Consumer Loans -5.1 -4.9 -3.8 -2.2
Non-Accruing Loans -18.9 -23.0 -20.0 -19.7
NIM 5.4 0.0 -10.2 -7.6
NII 3.3 -1.9 -1.8 0.8
Loan Loss Prov -83.6 -32.2 -125.9 -95.3
Credit Income 22.7 5.9 22.5 17.7
Trading 2.2 12.8 6.1 -25
Operating Revenue 5.4 29.7 -8.1 -3.5
Pre-tax Income 336.5 -522.8 -99.6 10.5
Stock Price 29.2 425 -8.3 0.5