Combined profit at the six largest U.S. banks jumped last year to the highest level since 2006, even as the firms allocated more than $18 billion to deal with claims they broke laws or cheated investors.
A stock-market rally, cost cuts and a decline in bad loans boosted the group's net income 21 percent to $74.1 billion, according to analysts' estimates compiled by Bloomberg. That's second only to 2006, when the firms reaped $84.6 billion at the peak of the U.S. housing bubble. The record would have been topped were it not for litigation and other legal expenses.
Wall Street's largest banks, set to report fourth-quarter earnings starting Jan. 14, are contending with fresh accusations they misled buyers of mortgage-backed securities, rigged markets or turned a blind eye to suspicious activity by customers. JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon, whose company announced more than $23 billion in settlements of government and private disputes in the past 12 months, has said legal expenses at his firm will remain high.
"Legal-related costs significantly impacted results in 2013, and we think they'll stay elevated in the near term," Jason Goldberg, a New York-based analyst at Barclays Plc, said in a telephone interview. "Banks will try to get a lot done in year-end results to have less of a burden in 2014."
JPMorgan and Wells Fargo & Co., the first to post results, will show the impact U.S. scrutiny is having on Wall Street.
Wells Fargo, the fourth-largest U.S. bank, is set to announce the biggest annual profit, surpassing JPMorgan's for the first time since 2009, according to analysts' estimates. Net income at San Francisco-based Wells Fargo, which relies most on retail banking and mortgage lending, is predicted to climb 4.1 percent in the quarter to $5.3 billion. For the year, analysts estimate about $21 billion, a fifth straight annual record.
JPMorgan, the nation's biggest bank by assets, will probably say profit slid 14 percent to $4.9 billion, according to analysts. The firm's annual profit may drop 21 percent to $16.9 billion, snapping three straight years of records.
The bank agreed this week to pay $2.6 billion to resolve criminal and civil allegations it failed to stop Bernard Madoff's Ponzi scheme, a deal JPMorgan said will cut fourth- quarter earnings by about $850 million. In November, it reached a record $13 billion settlement of probes into mortgage-bond sales. The New York-based firm also resolved inquiries last year into botched derivatives bets, energy-market manipulation and credit-monitoring products.
JPMorgan allocated $11.1 billion to litigation and legal costs during the first nine months of 2013, the most among the six lenders, according to quarterly reports banks filed with the Federal Reserve. That compared with $4.8 billion at Bank of America Corp. and $1.4 billion at Citigroup Inc.
The six banks' combined litigation and legal expenses in the nine months rose 76 percent from a year earlier to $18.7 billion, higher than any annual amount since at least 2008. The costs increased at all the firms except Wells Fargo, where they fell 1.2 percent to $413 million, and Morgan Stanley, which reported a 14 percent decline to $211 million.
"Even into 2014, legal could be a drag for the whole industry," said Pri de Silva, senior banking analyst at CreditSights Inc. in New York. "But it can't be any worse than it was last year."
Spokesmen for the six banks, which also include Goldman Sachs Group Inc., declined to comment.
Settlements don't always hit a bank's earnings in the same quarter. That's because firms set aside reserves as costs become probable, sometimes years before cases are resolved.
JPMorgan wasn't alone in settling government claims in 2013. Citigroup and Wells Fargo were among six firms that paid almost $3.9 billion to resolve Federal Housing Finance Agency claims that they sold faulty mortgage bonds to U.S.-controlled Fannie Mae and Freddie Mac. Bank of America also agreed to an $11.7 billion package designed to resolve most mortgage disputes with Fannie Mae.
Last year was the best for U.S. financial stocks since 1997. The 24-company KBW Bank Index climbed 35 percent amid a broader rise in equities and an accelerating U.S. economy. The industry's revenue from equity trading probably jumped 33 percent from a year earlier, Matt O'Connor, a New York-based analyst at Deutsche Bank AG, wrote in a Dec. 20 note.
Annual earnings at Bank of America, the nation's second- largest lender, and Citigroup, the third-biggest, surged in 2013, according to analysts' estimates.
Bank of America, scheduled to announce results Jan. 15, may have boosted fourth-quarter profit more than four-fold to $3.3 billion, according to the estimates. Net income for the year may amount to $11.2 billion, the most that the Charlotte, North Carolina-based lender has earned since 2007. Bank of America's earnings rebounded from a year ago, when profit in the fourth quarter fell to $732 million because of mortgage-related settlements.
Citigroup, set to report a day later, is estimated to say profit more than doubled to $3.14 billion in the quarter or $14.2 billion for the year, the most since 2006. Earnings rebounded from a year earlier, when the New York-based firm booked costs tied to a mortgage settlement.
Probes weren't the only drag on earnings for banks in 2013. A slump in fixed-income trading probably cut revenue from that business 10 percent, according to Deutsche Bank's O'Connor.
Goldman Sachs, which set a record for fixed-income revenue in 2009, suffered the steepest decline at 23 percent, he estimated. The New York-based firm, the nation's fifth-largest bank, will say quarterly income fell 28 percent to $2.09 billion when it reports results Jan. 16, according to analysts' estimates. Morgan Stanley is set to report results a day later and will probably say that profit for the period rose 70 percent to $859 million.
The reduction of monthly bond purchases by the Fed may continue to damp fixed-income trading. Rising interest rates linked to Fed actions also cut mortgage revenue last year as fewer homeowners refinanced.
"There was hope that with the start of tapering and the resolution of the Volcker Rule, there would be more trading activity, but I don't think that happened, so fixed income will be lackluster," said Charles Peabody, an analyst at Portales Partners LLC in New York, referring to the part of the 2010 Dodd-Frank Act that seeks to curb proprietary trading by banks. "Mortgage banking will remain in the doldrums until mid-2014."
Banks are focusing on expenses they can control, Erika Najarian at Bank of America wrote in a Dec. 16 note. The six biggest lenders reduced their workforce by 29,000 in the first nine months of 2013, or 2.6 percent, data compiled by Bloomberg show. Many cuts targeted mortgage personnel.
As firms report results, investors will focus more on executives' forecasts for 2014 than last year's numbers, said Richard Staite, an analyst at Atlantic Equities LLP in London, who cut profit estimates for the three biggest U.S. lenders because of higher legal costs and weaker fixed-income revenue.
"We expect management comments during conference calls to generally remain upbeat with stronger economic growth, a steeper yield curve and stronger equity revenues all being supportive," Staite said in a Dec. 19 note.
An improving U.S. economy could bolster Wall Street operations and wealth-management businesses this year, Brad Hintz, a New York-based analyst at Sanford C. Bernstein & Co., wrote in a Jan. 3 note.
Signs of strength were apparent in the fourth quarter, he said. Initial public offerings doubled over the year-ago quarter and drove a 50 percent increase in equity capital markets business, he wrote. New York-based Morgan Stanley, which owns the biggest U.S. brokerage by number of advisers, will report that revenue from that division increased 5 percent to $3.6 billion, according to Hintz's estimate.
"It appears that 2014 may prove to be a typical cyclical recovery for the institutional business major investment banks, with Morgan Stanley and Goldman Sachs most levered" because of mergers and acquisitions and capital markets units, Hintz said.
JPMorgan remains under a cloud of legal and regulatory investigations. It's among firms facing U.S. probes into whether hiring in Asia violated anti-bribery laws, as well as possible manipulation of interest rates and currency benchmarks.
Legal costs that averaged $500 million a quarter could be $1 billion to $2 billion for a few years, Dimon told analysts in an Oct. 11 conference call. The firm is spending also $2 billion to improve compliance by the end of 2014, he said last month.
"We would love to reduce the uncertainty around this for ourselves and for you, but it's very, very hard to do," Dimon, 57, said in October. "Remember there are multiple agencies involved in every case now."