Is There Relief for the Banking Sector

tarun is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Recently the largest Money Center Banks, Wells Fargo & Company ) and JPMorgan Chase & Co. ), had released their results suggesting that the housing market is reviving as there's an upsurge in housing finance fueled by record low mortgage rates.

The Earnings & The Goods

JPMorgan, the largest bank by assets in the United States, reported record third-quarter earnings. The net income surged by a massive 33% to $5.7 billion from $4.3 billion a year earlier. The increase in net profit is mainly due to mortgage lending. The Volker Rule, (specific details of the rules have not yet been finalized) named after ex-Federal Reserve Chairman Paul Volcker basically prohibits banks from proprietary trading that means investing your own money for your own profit. This change requires banks to remodel their business from lucrative and risky moneymakers like derivative trading to conventional and stable business such as mortgage lending.

Wells Fargo, the largest mortgage originator and the third largest bank by assets, also reported its third quarter earnings along with JPMorgan. Like JPMorgan, booming mortgage business helped Wells Fargo report a profit of $4.9 billion, a 22% jump compared to same quarter last year. The Bank's lending arm led to this growth, as consumers refinanced their mortgages at lower rates of interest. The bank has also benefited from its diverse operations. It boosted its investment banking, capital markets and trading businesses by its acquisition of Wachovia in December 2008. Wells Fargo’s trading unit is small compared to its heavy-weight competitors; still it has extended services to hedge funds over the years with acquisitions.

Citigroup (NYSE: C) also reported its earnings recently beating analysts’ expectations though profits have fallen. The net profit fell by 88% to $468 million and the revenues fell down by 33% to $14 billion on the year. Revenues were impacted by a pre-tax loss of $4.7 billion on its stake in Morgan Stanley Smith Barney. Revenues and earnings were also impacted by a negative credit valuation adjustment of $776 million. The Bank's net interest margin have actually risen to 2.86 percent from 2.83 percent last year, while the margins on lending for competing banks have been shrinking.

The Legal Odds

Citigroup's mortgage units are still attracting lawsuits and regulatory charges. The bank had agreed to settle lawsuits from shareholders, who said the bank didn't properly warn them of its exposure to risky subprime debt. JPMorgan suffered trading losses because of enormous bets on derivatives by Bruno Iksil, the London Whale. Initially, hedge fund managers were betting on credit default swaps (the derivatives on which Bruno was trading) but as they wised up and started trading against JPMorgan, its losses mounted. The loss was initially reported at $2 billion but in July it was updated to $5.8 billion. It appears the losses are still going to increase and might mount up to more than $10 billion. There is no doubt that the depositors' money is at risk and could potentially affect other portfolios and wipe out JPMorgan's entire capital base. Investors should think twice before parking their savings in JPMorgan.

Wells Fargo is also facing a series of legal actions and the latest has been filed by the Manhattan's U.S. Attorney's office and is accused for its misconduct in mortgage lending practice. The Bank has recently settled $175 million as charges by the department and hundreds of millions might follow suit.

The Final Words

The revival of housing finance should help banks' revenues and earnings improve in the coming quarters. The global economy and demand for certain loans is still sluggish, and low rates might affect revenues. The laws are becoming more stringent that might shift conventional, boring and less risky banking back in style.

The discussed banks have delivered top line earnings; though Citigroup’s profits slipped, they have performed better than analysts’ estimates. Citigroup though, is still reviving from its financial crisis but with the help of governmental aid and restructuring initiatives it has achieved a strong capital base. The company is trying to revive itself from its legacy positions, and its global presence, even in emerging markets, gives it a competitive advantage from its domestically focused peers. Citigroup's unique franchise allows its clients to access high growth foreign markets which should further strengthen it. The management’s ability to execute growth initiatives successfully in the changing regulatory environment will help it prosper and offer good returns to investors.

JPMorgan and Wells Fargo have performed well and have strong balance-sheets. Wells Fargo loan loss reserves have reduced due to improved asset quality and its excess capital position provides flexibility. It still remains exposed to interest rate risks and might be negatively impacted because of its exposure to derivatives which are used to hedge their interest risks. Strong execution of core banking operations and reinvestment of excess earnings for future growth should maximize net interest margin for Wells Fargo making it a good investment opportunity


tarunbachhawat has no positions in the stocks mentioned above. The Motley Fool owns shares of Citigroup Inc , JPMorgan Chase & Co., and Wells Fargo & Company. Motley Fool newsletter services recommend Wells Fargo & Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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