Editor’s note: Related tickers: Bank of America Corp (NYSE:BAC), Goldman Sachs Group, Inc. (NYSE:GS), Wells Fargo & Co (NYSE:WFC), JPMorgan Chase & Co. (NYSE:JPM)
Everywhere you turn someone has an opinion about the big banks. On one channel you hear about “too big to fail“, on another you hear about “too big to jail“, and in the morning paper you read about record year end profits despite a $6 billion+ trading loss earlier in the same year. What, exactly, are we to think of the big banks?
Photo Credit: Coolcaesar
To answer that question I’ve compiled 7 charts that paint a picture with data, not opinion. The takeaway? You’ll have to see for yourself–the conclusion will surprise you.
1. The Banking Sector is getting healthier
Source: FDIC Quarterly Banking Profile
Overall, the banking industry is getting healthier, but there is still a little ways to go. Bank failures are down considerably from the peak in 2009 along with the number of problem banks as identified by the FDIC.
The Federal Reserve’s stress tests earlier this year had a similar result. By and large the biggest US banks did well.
Bank of America Corp (NYSE:BAC) performed surprisingly well, a testament to the strategy put in place by CEO Brian Moynahan. Goldman Sachs Group, Inc. (NYSE:GS) had disappointing results from a capital and loan concentration perspective, but still passed the test. Wells Fargo & Co (NYSE:WFC) faired well, but like Goldman showed some unexpected weakness. JPMorgan Chase & Co. (NYSE:JPM), long considered the strongest of the big banks, surprised observers by finishing 3rd from the bottom.
All of these results point to a stronger financial sector in general, characterized by stronger capital bases to protect the banks from future economic shocks.
2. Loan Growth is Back
Source: FDIC Quarterly Banking Profile
After four years of negative loan growth, the FDIC is now reporting industry wide growth in total loans and leases for the last 4 quarters.
Growth in loans secured by 1-4 family residential properties are seeing the largest growth, primarily driven by residential mortgage loans.
Wells Fargo & Co (NYSE:WFC) is the nations largest mortgage lender with 33% market share and a mortgage servicing portfolio in excess of $1.9 trillion. JPMorgan is the second largest mortgage lender with 10% market share. JPMorgan Chase & Co. (NYSE:JPM) originated over $192 billion in mortgages in 2012. Together these two banks alone service nearly 50% of the entire mortgage market.
3. Banks are profitable again
Source: FDIC Quarterly Banking Profile
Banks have again returned to profitability, albeit not at the same levels of return on assets or return on equity as in the 1990s or 2000s. Expectations are for lower ROA and ROE across the board as the impacts of higher capital requirements work through the industry.
Goldman reported a 10.8% ROE for 2012, while Wells Fargo & Co (NYSE:WFC) reported 12.9% and JPMorgan Chase & Co. (NYSE:JPM) reported 11.0%. Bank of America Corp (NYSE:BAC) was a laggard due to lower profitability overall, reporting just 1.8%.
Investing is always a trade off of risk and reward. Lower ROE and ROA would be acceptable if the banking system were appreciably less risky than in 2007. However, these next charts indicate that risk may not be as improved as you’d think.
4. Profits are being squeezed
Source: FDIC
Banks today may be profitable, but that profit is increasingly hard to come by.
Fundamentally, banking is simple: banks accept deposits and pay the depositors a small amount of interest. They then use those deposits to make loans and charge a higher interest rate. The difference, the net interest margin, is loosely equivalent to gross profit.
Since the Savings and Loan crisis in the late 80s and early 90s, the industry’s net interest margin can be seen steadily decreasing. This pattern will continue, painfully so in the short term.
There are two numbers to consider for this analysis: the interest rate paid on deposits and the interest rate paid on loans. When interest rates rise, the rate paid on deposits will always rise faster than that paid on loans. This is because loans are generally longer term and the interest rates are generally fixed rate or variable rate that adjust periodically but not instantly.
When the Federal Reserve does move to raise interest rates, the rates paid on deposits will increase faster than the rate on loans. Therefore, the net interest margin will squeeze even further.
5. The big banks are being squeezed more than the rest
Source: FDIC
Historically, bigger banks have operated on smaller net interest margins than smaller competitors. This is a function of a big bank’s ability to provide additional services to generate income outside of interest income.
However, with the increased regulation currently being written and deployed targeting big banks, it will be unlikely that these institutions will be able to maintain the historical level of non interest income.
So at this point we’ve established that the industry is healing and banks are again profitable. But we also see that profits today are lower relative to assets and equity, and that its only getting harder to squeeze out each dollar of profit. Capital requirements are higher. Loan growth is increasing. Net interest margin is being squeezed.
Clear as mud?
6. Too Big To Fail
Source: FDIC Quarterly Banking Profile
One thing the Financial Crisis didn’t change is the steadily increasing concentration of bank assets. As of Dec. 31, 2012, the FDIC insured 7,181 institutions. Of those, only 108 had total assets greater than $10 billion.
Put another way, 1.5% of banks control over 80% of total assets.
Five years after the financial crisis the financial system is no stronger systemically than it was prior to the collapse of Lehman Brothers. Goldman Sachs has $939 billion in total assets. Wells Fargo has $1.4 trillion. Bank of America Corp (NYSE:BAC) has $2.2 trillion. JPMorgan has $2.4 trillion. This is a staggering and unprecedented concentration of assets.
It is very difficult to recommend an investment in any of the largest banks when viewed through this concentration risk. The Federal Reserve is doing its best to manage this risk with its public stress tests, but those tests are just simulations run on assumptions. If 2007 proved anything, its that we simply can’t predict the future (particularly “black swan” events).
7. Pigs get slaughtered
Source: Federal Reserve Board, Senior Loan Officer Survey on Bank Lending Practices
History has a way of repeating itself, and this chart paints a sad picture of what’s to come. Since at least 1990, banks have repeatedly shown an inverse relationship between loan demand and credit standards.
Repeatedly and conclusively, when there is strong demand for loans, banks loosen their standards to win deals.
Specific examples of loose credit standards have become household phrases since the mortgage crisis: low or no doc mortgage loans, funding a loan without verification of income, lowered FICO score requirements, and approving loans with tighter debt ratios. Loose standards lead to bad loans, which leads to losses.
So what does it all mean? It means that the big banks are getting bigger. It means the financial system is still as fragile as ever. And yes, banks have more capital today, and that improvment should be applauded.
But as banks start to grow again, you have to decide if today’s higher capital levels are sufficient for an industry with declining profitability, tightening margins, extreme concentration of assets, and a history of loosening standards at the exact moment they should be tightened.
The choice is yours, but my money is staying in my local community bank
© 2013 The Motley Fool. All rights reserved. The Motley Fool has a disclosure policy. This article was originally written by Jay Jenkins and appeared on Fool.com.
