To my way of thinking, the big banks share a common problem with their old-line counterparts in the airline industry. Like the legacy air carriers, the top banks in this country have yet to find a sustainable profit-making model in a changed world.
Consider the latest round of quarterly results. Earnings quality was mixed at best. Profit "growth" at Bank of America, for example, was primarily fueled by asset sales and reserve releases – one-time events unlikely to be repeated. Even JPMorgan Chase found it necessary to refer to the banking industry’s "malaise" when discussing the decline in pre-provision profits. A bird’s-eye view of the structural issues looming on the horizon makes me feel like a white-knuckle flier. I don’t want to get on the big-bank plane.
Like the legacy carriers, the big banks have been slow to adapt to the new order. Pan Am exemplified what commercial flying used to mean: glamour, comfort and a free hot meal. Then came the 1973 oil crisis. Fleet overcapacity and embedded cost structures conspired with the new reality of oil price-fixing by OPEC to turn Pan Am into a money pit. Corporate consolidations and capacity reductions ensued, but Pan Am never returned to solid profit growth.
Today the survivors of that Darwinian exercise in adaptation, the legacy carriers, have yet to demonstrate a convincing business model. Likewise, U.S. banking has yet to evolve to meet the cyclical and secular changes sweeping the economy.
Granted, the earnings-season news had some bright spots. Capital ratios for all the big banks improved in the fourth quarter as did asset quality. The optimists, however, are reading far too much into the balance sheet. Stronger capital ratios should come as no surprise given the deleveraging of the banking system as well as fiscal support provided since the Lehman Brothers bankruptcy. Deleveraging, though necessary, is not a business model. The banks face a future of feeble economic growth, a moribund housing market, chronically high unemployment, regulatory uncertainty and a low-rate environment for as far as the eye can see. And no industry is more tightly tethered to the macro business cycle than banking. So how are these banks going to make money?
On the retail front, it’s prudent to plan for a continuing decline in U.S. housing prices due to mortgage delinquencies, elevated inventory and low turnover. Even if the housing market is nearing a bottom, prices likely would remain stagnant for some time to come. That base case is an important data point for unresolved legacy issues as well as future loan volume. Litigation related to mortgage originations, servicing and securitization continues to loom large over certain banks. Although fourth-quarter earnings for the big banks showed a glimmer of hope for a pick-up in loan growth, it’s difficult to see how loan demand will improve in any sustainable way without an increase in employment.
On the commercial front, the banking system is subject to the same sweeping changes in technology that tend to presage major societal change. Symbolism speaks volumes about the major banks. Bank building architecture once favored imposing structures with Doric columns to conjure an implicit reassurance of the safety of your cash. Now you can deposit a check to your account with a wave of your smart phone. What, exactly, happens to all those buildings and people? Perhaps Brian Moynihan should give Ryan Bingham, the job-slasher for hire played by George Clooney in "Up in the Air," a call.