A Difficult Quarter Again Seen for Banks

By Dow Jones Business News, 
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By Saabira Chaudhuri

Halfway through the year, banks aren't exactly hitting their stride.

Despite growth in lending and near-record stock markets, the biggest U.S. banks are expected to show second-quarter results that continue to be hampered by low interest rates, slow trading conditions and big legal bills.

Wells Fargo & Co. starts off the bank earnings season Friday and is expected to show modest profit growth, according to analysts polled by Thomson Reuters.

But overall, the six largest U.S. banks--Wells Fargo, J.P. Morgan Chase & Co., Bank of America Corp., Citigroup Inc., Goldman Sachs Group Inc. and Morgan Stanley--are expected to show quarterly revenue declined 5.6% from the previous year, according to the analyst estimates. Profits are expected to fall 10.3%, to $19 billion, as banks face a tough comparison with a strong second quarter a year earlier.

"The environment clearly remains very difficult," said Chris Kotowski, a banking analyst with Oppenheimer & Co. He sees better times ahead when interest rates rise, but said the current climate for banks feels like "slogging through a malarial coastal swamp." Net interest margins, which measure the difference between what a bank makes on lending and what it pays depositors, have been squeezed as rates have stayed low. Indeed, large banks have been stuck in neutral since last year, when the six firms had their highest net income since 2006 and finished the year following five consecutive quarters of profit and revenue growth. Both streaks ended in the first quarter.

Some analysts said the slump may be temporary. Legal costs, which will likely be an issue for Citigroup and Bank of America in the latest quarter, could subside soon. Lending growth is accelerating. And some of the downturn is explained not by fundamental weakness, but by the expected absence of a significant tailwind seen last year from big reductions in reserves set aside for potential loan losses.

Still, trading desks, once a lifeblood for investment banks, have experienced a slowdown that has hampered revenue and profit growth. In the business of trading fixed-income investments like bonds, as well as currencies and commodities, investors' reluctance to trade has been compounded by other problems, including regulations that make it harder for them to take risks and make short-term profits.

"We frankly have no idea where the bottom is" in the fixed-income trading business, said Mr. Kotowski. Some analysts recently cut their earnings estimates on investment banks as far out as 2016, citing what they say will be a prolonged slump in the trading business.

More recently however, there have been a few rays of hope in trading as client activity appears to have picked up in June.

"People who were saying at the beginning of the quarter that fixed income was going to be off terribly, my guess is they'll probably do better than they expected," said the head of one investment bank. June trading volumes have looked better especially in the rates business, said another banking executive.

In Europe, average daily electronic fixed-income brokering volumes at ICAP sharply increased in June from levels in April and May, while volumes on foreign-exchange trading platform EBS also increased in June.

Other bank executives caution, however, that the June relief might turn out to be short-lived. And it isn't clear if the pickup will be significant or widespread enough to prevent the expected trading declines in the second quarter forecast by banks, including J.P. Morgan and Citigroup.

A slump in trading is expected to be mitigated by stronger investment-banking revenue in the second quarter, with mergers-and-acquisitions revenue showing robust growth from a year earlier.

Meanwhile, loan growth is expected to have stayed strong in the second quarter. Commercial and industrial lending is expected to continue to increase, while consumer lending could also start picking up. Analysts at Deutsche Bank recently noted that loans for the largest 25 U.S. banks are up 2.2% as of the second quarter's end from a year earlier. Mortgage banking is also expected to rebound, though overall levels remain low compared with the refinance boom that ended in the second half of last year.

One lever for banks to boost profits even as revenue stays sluggish is cutting expenses. But analysts warn that much in that area has already been done. And large additions to litigation reserves in recent quarters have weighed on cost-cutting efforts of some big banks.

For the second quarter, analysts expect Bank of America to add between $1 billion and $4.6 billion in legal costs tied to a potential settlement with the Justice Department. Separately, Morgan Stanley analysts recently cut their earnings forecast for Citigroup after The Wall Street Journal and other media reported that Citigroup was near a $7 billion settlement with the Justice Department over soured mortgages.

Eyk Henning and Matthew Turner contributed to this article.

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