This gap in the banking industry reflects the bifurcated rebound in the United States from the pandemic.

The stock market has largely recovered from the crisis and companies are raising record sums of money in capital markets. But the real economy is still in crisis. Millions of Americans are out of work, countless small businesses are on the verge of collapse and corporate bankruptcies are mounting.

“Time is the killer in this. The longer this pandemic goes on, the worse it gets,” said Chris Marinac, a banking analyst and director of research at Janney Montgomery Scott.

Bad-loan war chest boosted by another $31 billion

Big banks are planning for the worst by ramping up cushions against bad loans.
JPMorgan (JPM), Bank of America, Wells Fargo, Citi (C), PNC and US Bancorp (USB) set aside a combined $31.1 billion in additional loan-loss reserves during the second quarter. Although prudent, those moves sharply dented profits and reflect a sense that more trouble in the real economy is coming.

“Bankruptcies continue to rise. There is continued stress in the labor market. This is not going to be over anytime soon,” said Constance Hunter, chief economist at KPMG.

Bank of America (BAC), for instance, set aside another $4 billion to guard against loans that go bad because of the “weaker economic outlook related to COVID-19.” Those credit losses drove a 52% plunge in Bank of America’s profit.
PNC (PNC) ramped up its loan loss reserves by $2.5 billion, causing the super-regional bank to post a loss based on continuing operations.

“We’re still in the middle of the storm. Banks are focused on getting ahead of it,” said Marinac.

Low rates mean weak profits

But it’s not just the mounting loan loss reserves dinging banks.

They’re are also getting squeezed by the extremely low interest rates imposed by the Federal Reserve to soften the blow from the pandemic. Banks make much of their money on the difference between interest charged on loans and interest paid on deposits. Near-zero rates crush that gap, known as net interest income.

That key metric of bank profitability fell 4% quarter-over-quarter at JPMorgan and 11% at Bank of America.

Wells Fargo’s (WFC) net interest income tumbled 13% because the bank is still under Fed sanctions for its countless consumer abuses. Those Fed penalties cap the size of Wells Fargo’s balance sheet, making it impossible for the bank to offset pressure from low rates by lending more.

Buy analysts are confident the big banks can weather the storm, for now at least. That’s because they were forced after the Great Recession to bulk up on loss-absorbing capital for the next crisis.

And one bright spot in the Main Street business is housing, which is being boosted by record-low mortgage rates and a desire by many city dwellers to head for the suburbs.

For instance, US Bancorp’s mortgage banking revenue more than tripled during the second quarter from the year before.

Gangbusters quarter for Wall Street banks

While banks’ Main Street businesses mostly stumble, the Wall Street side of the industry is cruising.

Morgan Stanley’s revenue jumped 30% during the second quarter to a record $13.4 billion. Goldman Sachs grew revenue by 41%, the second-best quarterly haul in the bank’s history.

Both companies are thriving on a surge of trading activity.

Morgan Stanley’s sales and trading revenue surged 68% from a year ago on “elevated client activity.” Fixed-income trading revenue nearly tripled to $3 billion thanks to “robust global capital markets activity.”

Likewise, Goldman’s fixed-income trading revenue hit a nine-year high, while its equities unit brought in the most revenue in 11 years.

“There was a lot of volatility — and that’s good for business,” said Marinac.

It’s not just that people were trading more.

The Fed’s emergency actions, including its unprecedented promise to buy junk bonds and other corporate debt, flung capital markets wide open after they essentially shut down in March. US companies raised nearly $190 billion through stock sales during the second quarter — more than ever before, according to Dealogic.
That kind of dealmaking is music to the ears of Wall Street banks, which get paid to underwrite IPOs and other stock and bond sales. Goldman Sachs (GS) reported record revenue for underwriting both debt and stock sales.
Of course, the strong capital markets didn’t only benefit Goldman and Morgan Stanley (MS). They helped to cushion the credit losses for the more diversified big banks. For instance, JPMorgan’s corporate and investment bank reported an 85% profit leap on record revenue. Its trading business also grew sharply, with a 99% spike in fixed-income trading revenue. Without booming markets, JPMorgan’s profits would have tumbled much further.

Yet analysts — and even bankers themselves — warn that the roaring investment banking revenue is unsustainable. Eventually, these trends will flatten out.

Wall Street CEOs aren’t banking on V-shaped recovery

Bank executives, in stark contrast to the euphoria on Wall Street, struck a decidedly cautious tone this week.

Jennifer Piepszak, JPMorgan’s chief financial officer, said the bank is prepared for double-digit unemployment through the first half of next year. The Fed, on the other hand, has been projecting that unemployment would get down to 9.3% by the fourth quarter of this year.

“You’re going to have a much murkier economic environment going forward than you had in May and June,” JPMorgan CEO Jamie Dimon said. “We are prepared for the worst case. We simply don’t know. I don’t think anyone knows.”

Wells Fargo boss Charlie Scharf simply said, “The economic recovery will not be smooth.”

All of this suggests the road ahead will be challenging for big banks. Until the real economy gets back on its feet, banks will struggle.

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