The yearlong trend of paper profits powering banking results may be coming to an end.
JPMorgan Chase & Co.'s cautious outlook on U.S. consumers' ability to stay current on mortgage and credit card payments leads to that conclusion.
The inability for banks to declare as profits money set aside to absorb losses would be a heavy blow to the industry. Businesses and consumers aren't borrowing, and banks are reeling from new laws that restrict the fees.
"The revenue outlook outside of mortgage production is terrible. Loan growth sucks. Net interest margin is continuing to contract. Capital markets businesses are bad. Asset management isn't looking that great," said Keith B. Davis, a principal and research analyst with Farr, Miller & Washington in Washington.
"If you are running out of opportunities to drop [loss] reserves to the bottom line, where are you going to get your income growth?"
JPMorgan Chase's numbers showed that prolonged unemployment is taking a toll on borrowers' financial health. It reported softer third-quarter profits on a Wall Street slowdown that undercut gains in its retail bank.
Profits fell in all business units except retail banking, where earnings more than tripled on higher mortgage and debit card fees as well as a large decrease in noninterest expenses. Its top moneymaker — its market-leading investment bank — suffered as expected as debt woes in the U.S. and Europe stymied corporate and investor activity. Overall profits of $4.3 billion were down 22% quarter to quarter and 4% from a year earlier.
For some market watchers, JPMorgan Chase's actual results did not disappoint. What did was the downbeat credit outlook from Jamie Dimon, its chairman and chief executive.
"It's hard not to be cautious now," Dimon said, explaining why the company decided to set aside more provisions to cover losses while slowing down the draw-down of its loss reserves.
"Of course, everyone noted the cautious tone," said Gary Townsend, president and CEO of Hill-Townsend Capital LLC in Chevy Chase, Md.
If JPMorgan Chase is preaching caution, he said, "it's going to be hard for anyone to report and say particularly happy things about what they've seen in the third quarter."
Citigroup Inc. and Wells Fargo & Co. are schedule to report Monday, and Bank of America Corp. on Tuesday. Regional and community banks will follow.
"It's pretty clear that this is apt to be a difficult earnings season for banks," Townsend said.
JPMorgan Chase's loan losses continued to fall and are much lower than they were a year ago. Dimon said credit offerings to midsize and large corporations were "exceptionally good." But consumer borrowing trends are mixed. JPMorgan Chase economists are forecasting home prices to fall an additional 1% to 4%. Home equity delinquencies are ticking up. The rate of people missing a single credit card payment, while improving in the quarter, did so at a slower rate as unemployment hovers at around 9%. That raises the prospect of the sharp declines in credit card losses that the bank has been booking for several quarters are petering out.
The question of the hour for banks: How long will that difficulty last? JPMorgan Chase's numbers suggest a while.
The bank expects investment banking to remain soft through at least the fourth quarter. Making money in the simpler deposit-and-loan gathering business just got more difficult under newly enacted restrictions on how much banks can charge retailers for processing debit card transactions.
It estimates that change will reduce consumer and business banking revenue by more $300 million during the rest of 2010 and more than $600 million in 2011.
Its outlook on future loan losses dimmed on renewed jitters about the economy.
The quirky nature of bank accounting means banks sometimes have to set aside more money to cover future losses, even as their actual losses are declining. Banks' 2010 and 2011 profits have been boosted by recovering some of the provisions they made in 2008 and 2009.
JPMorgan Chase's reserve recapture slowed sharply in the most recent quarter. Its linked-quarter reserve decline was just $170 million, compared with declines of $1.2 billion and more than $2.6 billion in the previous two quarters, respectively.
Its reserve now stands at about $28.35 billion. It upped loss provisions in a handful of business units in the third quarter, even as overall credit health improved outside of mortgages. Though some of that increase was due to loan growth —accounting rules dictate that new loans come with loss coverage — it also reflected how problem borrowing costs are falling at an increasingly slowing rate.
Total provisions for the third quarter were $2.4 billion, up 26% from the previous period and 29% from last year.
Like other banks, JPMorgan Chase is reducing expenses.
While the bank has no formal cost-cutting initiative, it will be "looking at products and services" over the next six to nine months to determine where it can trim costs, exit certain areas and raise prices to offset that revenue hit, Dimon said.
It now expects to rein in its branch growth, too. It no longer intends to build more than 250 branches this year as closures of weak offices offset new construction in places like California and Florida, Dimon said.
Chief Financial Officer Doug Braunstein told analysts that given current conditions, "it's not unreasonable to expect that the fourth quarter will look like the third quarter" in the investment bank.